Down Payment Advice: Roll 401K into IRA into Down Payment

14 Replies

Hey All,

I plan on purchasing my first property by the end of the year and I'm thinking about how to most effectively use my funds/savings for a down payment (about 20-25K).

I amassed a small 401K balance with my previous employer (around 10K), and rather than rolling it into my new employers' 401K, I figured I could get a better return by using the money towards a down payment.  

From my initial googling-around, it seems like rolling the 401K into a self-directed traditional IRA and using that towards the down payment would be my best bet (will be taxed, but won't have to pay 10% penalty if I just pulled money out of the 401K).

Has anyone ever done this before, or planning on doing it? Would appreciate your thoughts on whether or not this is a great/terrible idea. 

P.S. Going forward, I do plan on saving up some money in my new employers' 401K program to take advantage of their profit sharing model. But, I won't be contributing the max amount as I want to funnel most of my cash towards real estate. 

Yes a self directed IRA is wonderful. You can use that money to invest in real estate, or you can be a private lender to other investors. There are a handful of self directed IRA custodians in the country, find one of them and ask them what to do The paperwork is really simple.

In no way is this legal advice, but you may want to look at rolling into a Roth Self Directed IRA where the profits from your real estate transactions will also be tax free. That really matters if you are wholesaling or flipping houses. A $50k chunk of cash can have some taxes attached if you dont structure your IRA correctly

To your success

Josh

@Josh Caldwell

You can transfer the former employer 401k to a self-directed IRA and then invest in real estate. If you won't have enough funds in the IRA to cover the full purchase, the following banks lend to IRAs on a non-recourse basis.

[REMOVED]

When you roll the 401k money into an IRA, the IRA can then buy real estate. But that real estate must belong to the IRA, not you. You cannot use that money as part of the down payment to buy a property in your own name. With only $10K in play, its unrealistic to think about using that for the IRA to acquire a property. The non-recourse loans you can get in an IRA require large down payments, typically 30+%. You cannot personally guarantee those loans.

If your IRA does own real estate, you MUST have sufficient reserves in your IRA to cover any problem. If you have a major problem and need $5000 to fix it, that money must come from your IRA. Or, your IRA must borrow it. You cannot put in your money. You cannot do work on a property your IRA owns.

@Greg N. hit the critical point here. Yes, it is very possible to use IRA funds to purchase property and to obtain a non-recourse loan to do so. However, the amount you are working with would not likely make such a strategy available to you.

The topic of self directed IRA's and non-recourse loans has been covered pretty extensively here on BP. Using leverage in your IRA is:

A) Doable in the right circumstances

B) A touch more complex, due to the requirements of the loan being non-recourse and the UDFI tax that applies to the percentage of income derived from non-IRA funds

C) A very powerful tool that allows you to use leverage in your IRA and obtain a higher cash-on-cash return for your IRA dollars.

My suggestion for you at the current time would be to either keep saving those IRA funds elsewhere and work towards building enough to take advantage of the ability to invest your retirement savings in tax-sheltered real estate in the future, or consider a self directed IRA but with a focus on doing things more manageable with your available capital such as short term private loans to unrelated parties for rehab costs, bridge loans to wholesalers, etc.

Originally posted by @Greg N. :

I plan on purchasing my first property by the end of the year and I'm thinking about how to most effectively use my funds/savings for a down payment (about 20-25K).

I amassed a small 401K balance with my previous employer (around 10K), and rather than rolling it into my new employers' 401K, I figured I could get a better return by using the money towards a down payment.  

From my initial googling-around, it seems like rolling the 401K into a self-directed traditional IRA and using that towards the down payment would be my best bet (will be taxed, but won't have to pay 10% penalty if I just pulled money out of the 401K).

Greg, I think you are confusing two different strategies in your proposal above. You can pull up to $10,000 penalties-free from your IRA if you are a 'first-time' home buyer. Home means primary residence, not an investment property.

The second element that you mention us using self-directed IRA to buy the property. You could do so, but as Jon and Brian mentioned with the little amount of money you have it is not realistic. Also, you would not be able to combine those funds with your personal savings for a down-payment. Do your due diligence, but speak with the expert who will take the time to understand your goals and will help you with creating workable plan.

Hey Greg, I really like the idea of keepin the money into your 401K and make it a solo if it not already. Of the guys that have posted here. I would rely upon what 

Dmitriy Fomichenko

has said. One of the other guys that posts here has not been as responsive to some of us. So I would be cautious. Also another powerful source is Jim Hitt with American IRA Google him. This guy manages over $300,000,000.00 in assets.

I would be happy to give you any real estate answer you might need. 

I hope yall have a great day.

Originally posted by @Josh Caldwell :

Yes a self directed IRA is wonderful. You can use that money to invest in real estate, or you can be a private lender to other investors. There are a handful of self directed IRA custodians in the country, find one of them and ask them what to do The paperwork is really simple.

In no way is this legal advice, but you may want to look at rolling into a Roth Self Directed IRA where the profits from your real estate transactions will also be tax free. That really matters if you are wholesaling or flipping houses. A $50k chunk of cash can have some taxes attached if you dont structure your IRA correctly

This is absolute nonsense, and I strongly recommend anyone wanting to do this first contact a CPA or tax attorney. I created an SDIRA on January 1st of this year, and used it to purchase an LLC that is 100% owned by my IRA (via the custodian) and managed by me (as a non-member manager). So far, so good.

I already knew that using an IRA to buy and hold real estate (rentals) was a bad idea, since you lose out on all the personal deductions associated with said venture. As a result, I did flip financing through my IRA, just as Josh is wholeheartedly recommending that you all do.

I have found out from my CPA that my IRA will be paying several hundred thousand dollars in UBTI (Unrelated Business Taxable Income) on the profits it made on the flips - taxed at corporate rates. It doesn't matter if you're wholesaling or flipping houses - you will, for all intents and purposes, be taxed twice on your money...

If you have a traditional IRA or 401(k) - one where you contribute pre-tax dollars - you will be taxed on UBTI as well as when you withdraw your money upon retirement... taxed twice on what someone tried to represent to you as a smart investment.

If you have a ROTH-type IRA or 401(k) - one where you contributed post-tax dollars - you have paid taxes on the money you contributed, and you will be taxed on UBTI when you use that money for flips... taxed twice on what someone tried to represent to you as a smart investment.

Please, folks... when dealing with financial matters, get the opinion of your tax agent or CPA... someone with a fiduciary duty to properly inform you of the consequences of your actions.

@Lew Payne

I dont have a dog in this fight but I literally know hundreds of self-directed roth IRA holders and I had never heard of anyone getting hit with UBTI in a Roth IRA. So I did some digging.

I hit the equity trust site and found this

UBIT (Unrelated Business Income Tax)

What is UBIT? When does it occur? And how can I remain compliant?


If your IRA owns an asset or interest that produces unrelated business taxable income (UBIT), your IRA may be subject to an unrelated business income tax (UBIT) pursuant to Section 511 of the Internal Revenue Code.

Is My IRA Responsible for UBIT?

UBIT applies if ALL of the following are true:

  • Income is derived from "trade or business" activity (i.e., sale of goods and services).
  • Business activity is not substantially related to exempt status.
  • Business is regularly carried on by organization.

Generally, IRA investments that can generate UBIT include:

  • Limited Partnerships (LPs),
  • Limited Liability Companies (LLCs), and
  • Any investment that incurs debt financing and/or is involved in an unrelated business.

I suspect that you problem occured because you bought an LLC and did business inside of it. Most IRA funders just use IRA money to fund deals in other LLC's that they either own or loan to. Contact your SIDRA holder and ask that question. Again, self directed IRA's are not my area of expertise. I have no reason to doubt you, but what you are describing is not the norm It is just my opinion based on the text above that buying the LLC is the cause of your problem, not the self directed Roth IRA

I hope that helps

Josh

Given the amount on money you are talking about, rolling it into your new 401K and taking a loan out may be the best approach.

A couple caveats:

1. make sure you plan to stay with your employer

2. make sure you can pay off the 401K loan rather quickly with income - even if the investment property isn't cash flowing

With the 401K loan, you would have 5K of the 10K available.  If you take the tax(and possibly penalty), you probably aren't ending up with much more cash and you don't have any of the 10K invested for retirement.

An even better use of the 401K balance would be as emergency reserves - so you have a source of quick cash if you need it in an emergency.

Originally posted by @Josh Caldwell :

@Lew Payne

I dont have a dog in this fight but I literally know hundreds of self-directed roth IRA holders and I had never heard of anyone getting hit with UBTI in a Roth IRA. So I did some digging.

I hit the equity trust site and found this

UBIT (Unrelated Business Income Tax)

What is UBIT? When does it occur? And how can I remain compliant?


If your IRA owns an asset or interest that produces unrelated business taxable income (UBIT), your IRA may be subject to an unrelated business income tax (UBIT) pursuant to Section 511 of the Internal Revenue Code.

Hello Josh - The key is "produces unrelated business taxable income" which means income derived from investments which are contrary to its tax-exempt nature.  It's the same as when a non-profit is taxed on businesses it derives income from that are not related to non-profit objectives, and that give it an unfair (tax-free) competitive advantage against businesses that are taxed in that area.

Unfortunately, these custodians (such as Equity Trust) are primarily concerned with getting clients, and have a vested interest in not making the laws crystal clear.  A certified agent or tax attorney can make it crystal clear for you.

Doing flips in an IRA of any kind (ROTH or not) results in UBTI, as an attorney specializing in tax representation can tell you, or one of the resource sites used by them can verify. I trust legal resource sites more than I trust third-party opinion, and I trust enrolled agents (federally licensed tax practitioners who specialize in taxation and also have unlimited rights to represent taxpayers before the IRS) more than accountants or standard CPAs.

"Most IRA funders just use IRA money to fund deals in other LLC's that they either own or loan to." If, as you say, they are funding deals in other LLCs they own, that is equivalent to making a loan to themselves, which is a prohibited transaction... even if they only own a fractional interest in the entity. If they are funding deals in other LLCs that they have no interest or control over, and are not receiving a deed of trust (or mortgage deed) as security for their transaction, then it may pass muster - but that's not a loan secured by real estate. If they're purchasing shares in an REIT or similar, that passes muster.

The fact that many people are unknowingly breaking the law is not a valid argument, so I'm not going to respond to that. I was in that boat until my CPA examined the transactions... I am fortunate, in that I'll simply pay the UBTI (and have my IRA profits cut by taxes). Those who partake in prohibited transactions (which has nothing to do with UBTI) will not be so lucky, should they be audited for any reason in the future.

Earlier this year, I even argued with someone in a thread over UBTI and various other 4-letter abbreviations, and how they didn't apply to my SDIRA (whether it's an SDIRA or an IRA LLC makes no difference as far as applicability of rules). I thought, just like you do, that I had interpreted the law correctly. I was wrong.

I hope this saves others from making the same mistakes.  Disregard advice that does not come from someone who is an enrolled agent (licensed to represent taxpayers before the IRS).  There are plenty of threads on here with terrible advice.  Don't fall victim to them.

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