Funding LLCs vs Properties/Deals

9 Replies

I have a partner who invests with me (putting in both money and effort), but her money comes from her (self-directed) IRA. To fund deals, we were thinking about having the IRA hold a note against the LLC (unsecured) as opposed to the property. It seems to require a lot of extra effort and paperwork for hard money lenders to have a 2nd lien-holder on the property, whether it be an IRA or a private investor's cash, so we thought this way would just bypass that and remove some headaches. Plus, we'd only have to do a loan transaction once a year (or however long the balloon is) vs every deal.

I'm just wondering... are there any legal or tax downsides to this?

Side note:  This partner and I have been close friends since middle school, so we basically have complete trust in each other.  We just really want to invest without legal headaches.

@Nghi Le  I can't provide you with the legal advice but I do have a question/comment.

You are saying that your partner used her IRA and puts both money and effort. Perhaps I'm misunderstanding what you are saying, what do you mean by "effort"? Please note that when it comes to using retirement account doing any work personally would be considered illegal contribution to the retirement plan.

Dmitriy Fomichenko, Broker
(949) 228-9393
Originally posted by @Dmitriy Fomichenko :

@Nghi Le  I can't provide you with the legal advice but I do have a question/comment.

You are saying that your partner used her IRA and puts both money and effort. Perhaps I'm misunderstanding what you are saying, what do you mean by "effort"? Please note that when it comes to using retirement account doing any work personally would be considered illegal contribution to the retirement plan.

I agree. From what I understand of the using of IRAs for real estate investing, doing ANY work be benefiting your investment....meaning your partners work could make the investment better or worse depending on his/her "efforts." That is illegal.

Originally posted by @Nghi Le :

Side note:  This partner and I have been close friends since middle school, so we basically have complete trust in each other.

Really? How close, Nghi? If this were completely true, you would work with each other on a handshake wouldn't you? There are many reasons you probably don't want to do what you're doing, and all of them are because you like and want to protect each other.

Bad things happen to good people. As a former house flipper some years ago, my 28 year old, out-of-state business partner and friend, was tragically killed in a car accident leaving me to fend for myself 2500 miles away with a contractor that defined the word "flake." It was not pretty and the word "sad" would be understatement.

Now, when my attorney puts stupid clauses in my contracts, "In case someone gets hit by a bus," … well, now I listen. How would your friend recover his or her assets from your LLC if something happened to you? A Note and properly recorded Mortgage or Deed-of-Trust protects all of you and your heirs in case something happens to one of you. Don't think it can't. You do it this way not out of a lack of trust, but because you care.

Second, I don't know the law in Washington, but in California, you cannot loan legally at more than 10% APR unless the loan is secured by real estate and originated by a licensed CA real estate broker. I also don't know your terms, but since real estate is involved, you should speak to a good lending lawyer (not a real estate lawyer) to make sure what you are doing is actually legal in your state. In CA, it might not be.

Frankly Nghi, I think you're playing with fire with your friend's IRA when you don't have to, and none of this is about trust. To the contrary, I'd never do business with anyone I don't know, like, and trust.

Good luck to the two of you.

Ahhh, was hoping for a more positive vibe.  But it sounds like I'm in for a learning experience, and good thing I had reached out to BP before anything happened.

@Dmitriy Fomichenko   & @Matt Nilson I didn't realize that doing work was considered illegal contribution. I thought the contribution was strictly monetary; i.e. can't invest both your IRA funds as well as your own personal one. But the scope of work that I was hoping my friend could do are things like helping me keep the project on schedule, which is nice because I work full-time and can't always pick up calls from contractors, architects, realtors, etc. My friend is not doing any of the rehab; I have a general contractor doing that. But I'm guessing even the admin work shouldn't be done? If not I can just say, "Sorry, you won't be able to help me."

Jeff S Na I'm really sorry to hear about your situation. And I don't consider the legal stuff "stupid", only overwhelming at this point in my REI career. What I was planning wasn't a long-term solution; it was basically to kick off and get my business started. Naturally, as I grow bigger and have more money, I invest more in the asset protection and legal stuff, but right now I just really want to jump in and do deals. There is at least a promissory note; wouldn't that help the other person regain something if something did happen to me? Otherwise, if you guys all feel this strongly about it, I'm willing to follow through with both a note and DOT.

Does this mean that any other private lenders I have, I should always have them lend on the property and not my LLC?

Hmm... I did some more research and found a lot of clauses saying that the person who lends with the IRA can't be involved in any of the real estate operations or "sweat equity". But this seems to occur when the IRA (partially) owns the property... does having a note on the LLC have the same rules?

Good info in here. I had no idea about this.

My business partner, who was my best friend from Elementary School (who ran all the business operations) hung himself this last November, out of no-where. It ended up with our business in a law-suit and my attorney's had told me had I not had an LLC set up to gain control of certain aspects of the company which I didn't previously have any part of it would have been even more of a headache. Much like Jeff, we didn't have a clause for what happens if one of the three business partners kills himself.

Can you cite a few of the clauses here @Nghi Le ?

I am curious as to how they distinguish "sweat equity" in the real estate industry from, for example, having your IRA own stock in the company that you work at.

Whether I work at a company the size of walmart or a 3 employee, family-owned C corp, it stands that I would be doing "work" to increase the value of that entity. Would it then be against IRA rules to hold the debt or equity of said company in my IRA?

That is interesting info. I had thought about moving some of my 401k into a self directed IRA to invest into real estate. I didn't know the investment had to be completely hands off. Good to know!

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