I've been reading up on the Self-Directed IRA, and from what I've found is that any cash flow/profit goes back into the SD-IRA. How does one legally obtain funds from a SD-IRA for basic living expenses if the purpose of your rental property is to replace your normal 9-5 income? Is the SD-IRA not the best vehicle for a rental property if you need to have access to the cash flow for your own personal daily expenses?
A Self-Directed IRA is not the right vehicle for what you propose.
All IRA plans have restrictions related to your access of the funds, such as a 10% penalty in addition to taxes on distributions taken before age 59 1/2.
All a self directed IRA accomplishes is providing you with a wider range of choices as to how to invest for your future self. it does not change the underlying tax rules for an IRA.
That's what I thought, just wanted to male sure I was interpreting things correctly.
Is there any alternative to taking a distribution from an old retirement plan, and doing a rollover to purchase investment property without taking a 20-30% hit from Uncle Sam if you want to have access to the cash flow?
If you are self-employed, you could establish a Solo 401k and then borrow up to 50% of your account up to $50K from the plan. That loaned money then becomes personal capital you can use to invest in real estate and keep the income.
This concept is pretty heavily promoted here on BP by folks who want to push the greed button to sell plans. We do not promote this strategy due to the high cost of accessing the money. In our opinion it is a short-sighted decision with negative long term implications.
You put the funds into the plan tax-deferred. You will repay the loan with after-tax money, so that 20-30% is really there as a cost, but just spread out over time.
Think seriously about rolling over the$$$ when leaving an employer. If you move it to a SD plan you can always lend it to others and learn more about RE investing through them and how they rehabbed or did their deal. You can learn AND make some money at the same time.
I have changed jobs a couple of times and several months later when the money is gone, I wished I would have rolled it over.
all retirement accounts are designed for you to build wealth in a tax-deferred to tax-free environment, to be used during the retirement.
The loan option that Brian mentioned above will probably not work for you either since you just need the income. When taking a loan from your 401k you are depleting the funds in your accounts that otherwise would be available for investment and it might come with the expensive price tag. I agree with Brian that one needs to carefully consider all factors before pulling the loan out.
It might be good for you to know that contributions to a Roth IRA can be withdrawn before retirement without taxes since you already paid taxes upfront. Conversion to a Roth could be one way to avoid paying penalties just the taxes if you need to pull the funds sooner. But be sure to consult with an experienced tax advisor about your particular situation.
The only other option I'm aware of and you might want to explore is the IRS Rule 72(t) which allows you to take a Series of Substantially Equal Periodic Payments before 59 1/2 (again, discuss this with the expert, I'm not a CPA and this is not a tax advise).
It is possible to w/d from your IRA penalty free for a first time home purchase. Although i think there is a limit of $10k.
If I restate your question as "Can I invest my IRA in real estate to increase my current cash flow?" It is possible if you are a qualified home buyer. There are exceptions to the penalties.
Here is the literature describing the exceptions to the 10% penalty from the IRS website.
To explain a little further...
So I suppose it is possible to withdraw money for your own house which would free up cash flow were you use it as a down payment if you don't already have it. The savings on your mortgage will decrease your monthly mortgage expense thereby increasing your cash flow. There are many rules that go along with this such as you must occupy the house for 5 yrs so I would probably it until you consult a CPA who can look at the specifics of your financial circumstances.
Hope that helps.
If you are looking to run your properties as a business, then the rollover as business start-ups 401k (ROBS) may be an option. Essentially, your ROBS 401k would sponsor a real estate operating company and you would be an owner employee. As long as you are managing and/or improving the properties, you can draw a fair salary. The following IRS website sheds more light on the ROBS.
An IRA may use debt-financing such as a mortgage secured by IRA owned real estate.
The mortgage must be non-recourse, meaning there is no personal guarantee coming from you or any other disqualified party to the IRA. This generally reduces the LTV and limits the choice of lenders willing to make such loans.
You can either pull cash from an existing property in this manner, or simply use a new mortgage when acquiring a property. Lenders will look at the acquisition cost of a property, so if you buy a property for $100K and increase the value, they would only lend on the $100K value for a significant period of time until the new value had been "seasoned".
When you use leverage in an IRA, there is a tax known as Unrelated Debt Financed Income (UDFI) that applies to the percentage of the income derived from the borrowed funds. The tax itself does not generally add up to much, and you will still very much receive the benefits of higher cash-on-cash return for your IRA, but this is a concept you will want to ensure you understand before you go into a financed deal.
Originally posted by @Matt Morgan :
Can you invest in a house with your sd Ira and the try to get a bank to open up a line of credit against that house to get cash to purchase other homes that would be excluded from your Ira?
Matt, if your IRA owns a house free and clear you can finance it and get a mortgage on it (I doubt you can get a line of credit). Those funds would have to go into your IRA since the IRA owns the property (not you personally) and can be used to acquire another investment property for the IRA.
The new loan that you obtain would have to be non-recourse, you are not allowed to provide personal guarantee using conventional mortgage.
Using those funds to buy personal property would not be allowed.
Just thought I'd add my two cents. An IRA is an important way for you to save for your retirement future (in addition to company sponsored retirement plans and personal savings) and that should not be neglected. Many individuals use IRA funds to invest 'off Wall Street' in an attempt to realize greater growth for the future. I always suggest that individuals contemplating real estate investments 'do the math' to determine the initial total cost of acquisition (year 1) and ongoing income/expenses including maintaining a cushion for any unanticipated expenses. If you were going to use IRA funds for a real estate investment any expense related to the investment (rehab, repairs, insurance, HOA) must be paid by the IRA - either out of income generated from the investment or from cash sitting in the account. I have seen investors get in trouble because they didn't have enough funds in the IRA to cover repairs after hurricane damaged the rental unit. The 'ROBS" approach could be a valid alternative (as suggested above) but you still need to do the math as there are costs associated with that investment structure.
@Sandra Reese Can you elaborate more on what" getting into trouble" means when you said "I have seen investors get in trouble because they didn't have enough funds in the IRA to cover repairs after hurricane damaged the rental unit." I am curious what this means if 1) you a self-directed IRA with an investment property and 2) you have an expense that the SD-IRA needs to pay for and 3) that the expense/repair/whatever cannot be covered by the cash reserves within the SD-IRA and 4) you are at your contribution limit for the year. Does that mean you run the risk of needing to cover the expense with non-IRA money which would then cause the entire exercise to become taxable with penalties?
I think the obvious answer is to keep enough cash reserves on had, but I am wondering what the potential (extreme) downsides are to investing in an investment property within a SD-IRA.
@Jennifer S. One thing that I think you could do that will partially meet your goal is to invest through a SD-Roth IRA in an investment property, have that property generate enough cash flow to cover your initial contribution (and be financially self sufficient with adequate reserves in place) and at a later date withdrawal funds equal but not exceeding your contribution amount. That way, you have set up a non-taxable investment property, and get your initial contribution back (although you cannot use the cash flow generated above the contribution limits until you reach retirement age of 59 1/2). You can always withdrawal the Roth IRA funds you have contributed but once you withdrawal "earnings", that is when you get hit with taxes and the 10% penalty. If you are single, it may take you a few years to contribute enough to use as a down payment, since the contribution limit is $5,500 but if you are married you can accelerate this through contributing $11,000/ year and using you and your spouses SD-IRA's as joint owners of the property.
Originally posted by @Jennifer S. :
How does one legally obtain funds from a SD-IRA for basic living expenses
You might be surprised that you can legally obtain IRA funds for living expenses. @Dan Cordoba would know the answer http://www.myrealestateira.com/ The 72t distribution is another area to look into. Good luck!
Can't she do a self directed Roth IRA, and then systematically withdraw her original contributions while letting the gains ride?
What @Sandra Reese means by "getting in trouble" is that if your IRA owns a property 100%, ALL of the expenses - repairs, taxes, insurance, condo fees, HOA fees,etc - must be paid with IRA funds. If the IRA does not maintain an adequate cash buffer, and there is some kind of major repair needed that is not covered by insurance, or a tax bill comes due and there is no rental income because the place is vacant, it is a prohibited transaction for the IRA owner to use his own personal funds to pay for any of these expenses. One solution would be for the IRA owner to get a non-recourse equity loan on the IRA-owned property. This would give the IRA an infusion of cash; however, those monthly mortgage payments need to be paid by the IRA, not the IRA owner.
A prohibited transaction can cause the IRA to lose its tax deferred/exempt status, it will be distributed, the income will be taxable, there'll be an early distribution penalty if the owner is under 59 1/2, and there'll be a punitive excise tax on top of this for the PT. Even if the IRA only owns a portion of a property, it is responsible to pay its percentage of expenses. An IRA and IRA owner can own a property as tenants-in-common, let's say 50%/50%. In this situation, the IRA must pay half the expenses and the IRA owner the other half. It would be a PT for the IRA owner to pay more than 50% of expenses (conversely, it's also prohibited for the IRA to pay more than its share of expenses if the IRA owner finds himself short on cash).
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