Phoenix, AZ · Member since 2016 · 6 posts · 3 votes
HI Everyone...
Just joined BP - I've been reading the forums for 1 month. Lots of great information. Thanks to everyone who is sharing their knowledge.
I am debating whether it is worth using my SD IRA to purchase real estate or is it better to use those funds for deed of trust investing or other avenues of investments.
I will not be able to access any rental income from the SD IRA until retirement, and since all gains in the SDIRA are not taxed - I will not be taking any advantage of depreciation or other tax benefits that I would investing with non retirement money.
Is there a pro / con list that can help me decide? Thanks
If you do, say, a fix-and-flip using your SDIRA, once the repairs are complete (enough), you can get a new appraisal and refinance to pay back your SDIRA with interest, as well as any other investors. Any excess becomes an advance on your profit when you sell, and the profit is then legally yours as the SDIRA has already been paid back. At that point, you selling and taking a profit is no longer a prohibited transaction.
If you are doing fixer upper in your IRA, most likely you will not be able to use a new appraised value to refinance the property. Most lender will require seasoning, as much as 3 years before they can use new appraised value. Until then the purchase price is used as the value of the property when you want to finance it.
When you sell the property owned by the IRA - the profit is not yours, the profit belongs to an IRA. You can not touch any of that. If you do pull any funds out - it would be considered a distribution, which is a taxable event and if this happens before retirement age penalties would also apply.
In addition that that, flipping activity may be considered an active business, and profit might be subject to Unrelated Business Income Tax.
With funds in an IRA, you simply want to evaluate the risk/reward of any particular asset as compared to other assets.
Notes are relatively low risk, require little interaction on your part, and produce consistent income.
Real estate is more work, and has increased risk such as tenant & contractor interactions.
What real estate offers that notes do not are the ability to use leverage such as a mortgage and the potential for appreciation in addition to cash flow.
There is no one answer as to which asset class is superior. it will depend on the numbers and your approach to involvement in your investments. It may be that you have a portfolio with both classes of assets.
If you do, say, a fix-and-flip using your SDIRA, once the repairs are complete (enough), you can get a new appraisal and refinance to pay back your SDIRA with interest, as well as any other investors. Any excess becomes an advance on your profit when you sell, and the profit is then legally yours as the SDIRA has already been paid back. At that point, you selling and taking a profit is no longer a prohibited transaction.
CAUTION: I am NOT a financial professional and this is NOT financial advice! Consult your financial professional for authoritative information. If you need one, I can refer you.
Generally, it is better to buy real estate personally (since you getting some tax benefits such as depreciation deduction) and buy trust deeds in your IRA (since in an IRA all of the interest income will be sheltered from taxes, but if you invest personally you will be taxed on those incomes every year).
But there are other factors to consider as well. There is no one strategy that is best for everyone. Good luck!
If you do, say, a fix-and-flip using your SDIRA, once the repairs are complete (enough), you can get a new appraisal and refinance to pay back your SDIRA with interest, as well as any other investors. Any excess becomes an advance on your profit when you sell, and the profit is then legally yours as the SDIRA has already been paid back. At that point, you selling and taking a profit is no longer a prohibited transaction.
If you are doing fixer upper in your IRA, most likely you will not be able to use a new appraised value to refinance the property. Most lender will require seasoning, as much as 3 years before they can use new appraised value. Until then the purchase price is used as the value of the property when you want to finance it.
When you sell the property owned by the IRA - the profit is not yours, the profit belongs to an IRA. You can not touch any of that. If you do pull any funds out - it would be considered a distribution, which is a taxable event and if this happens before retirement age penalties would also apply.
In addition that that, flipping activity may be considered an active business, and profit might be subject to Unrelated Business Income Tax.
If you do, say, a fix-and-flip using your SDIRA, once the repairs are complete (enough), you can get a new appraisal and refinance to pay back your SDIRA with interest, as well as any other investors. Any excess becomes an advance on your profit when you sell, and the profit is then legally yours as the SDIRA has already been paid back. At that point, you selling and taking a profit is no longer a prohibited transaction.
If you are doing fixer upper in your IRA, most likely you will not be able to use a new appraised value to refinance the property. Most lender will require seasoning, as much as 3 years before they can use new appraised value. Until then the purchase price is used as the value of the property when you want to finance it.
When you sell the property owned by the IRA - the profit is not yours, the profit belongs to an IRA. You can not touch any of that. If you do pull any funds out - it would be considered a distribution, which is a taxable event and if this happens before retirement age penalties would also apply.
In addition that that, flipping activity may be considered an active business, and profit might be subject to Unrelated Business Income Tax.
Once the SDIRA is paid off via the refi, the property is no longer owned or encumbered by it. So, no issues with prohibited transactions. It also does not need to be paid more than the agreed principal and interest. So, the excess can legally be taken as part of the investor's profit. On the final sale, all profit goes to the investors - no further issues or involvement with the SDIRA.
In my area here, we have no seasoning issues. Primarily because the property is acquired and rehabbed without an institutional lender.
The business entity's primary business IS real estate. So, no issues with UBIT.
I'm not sure the logic you express in your last sentence makes any sense. If the SDIRA is engaging in a trade or business on a regular or repeated basis (primary focus or otherwise) then it is subject to UBTI.
The code outlines that if a tax-exempt entity is engaging in a trade or business separate from its primary tax-exempt mission - such as a hospital providing healthcare - there is exposure to UBIT, such as if the hospital runs a bookstore. An IRA has no activity that in and of itself is such a tax-exempt mission.
If you are thinking that because the primary purpose of your IRA is to invest in real estate, that the IRS is therefore exempted from UBIT on flip income, you had better have a conversation with your tax advisor.
Solo 401k Expert · Anaheim Hills, CA · Member since 2012 · 18k+ posts · 6k+ votes
10y
@David Dachtera, after re-reading your original post I suspect that we might be talking about two different things here... Are you suggesting to him buy the fix-and-flip personally and use his SDIRA to fund it?
Not sure what you mean by "OP", please be clear in what you are trying to say on the public forum...
What you are suggesting would be prohibited transaction. The entity would be considered disqualified person to the IRA and therefore would be prohibited from engaging in any transaction with an IRA.
Phoenix, AZ · Member since 2016 · 6 posts · 3 votes
10y
Thanks Brian Eastman for clarifying active and passive investing through your IRA. I am interested in buying and holding investing not flipping. My understanding is that if I use my IRA to fund my investments I will not be able to get financing for future projects so I would not be able to use the leverage in equity to purchase new properties… Is that correct?
you can use leverage in an IRA, but the loan has to be non-recourse. Conventional financing can not be used. Here are some lenders who offer non-recourse financing:
The debt has to be non-recourse, meaning no personal guarantee from you. This limits your choice of lenders and the LTV they will lend, but it is still an ability to leverage the IRA dollars.
A non-recourse loan may be used for the initial purchase of a property, done as a re-fi or even applied as a portfolio loan to several properties held by your IRA.
The use of debt-financing creates exposure to a tax known as UDFI. Basically, the percentage of the income that is derived from the non-IRA money is taxed. After deductions, it does not generally add up to much, but does mean you need to be that much more involved in understanding the concept and have a CPA on your team who can handle the tax filing for your IRA.
Bottom line is that an IRA can leverage and will see the benefits of higher cash-on-cash return as a result.
If you do a fix-and-flip using your SDIRA, once the repairs are complete, you can get a new appraisal and refinance to pay back your SDIRA with interest.
David, what you are suggesting is incorrect and would put an investor in trouble. You can not use your IRA to fund your personal flips, this would be considered a prohibited transaction.
Not sure what you mean by "OP", please be clear in what you are trying to say on the public forum...
What you are suggesting would be prohibited transaction. The entity would be considered disqualified person to the IRA and therefore would be prohibited from engaging in any transaction with an IRA.
"OP" = "Original Post(er)"
No, it is NOT prohibited. Here's why: the entity is a corporation not owned by any human person.
If you need a reference to a tax and legal expert who understands this - and teaches it to newbie IRS agents - let me know.
If you do a fix-and-flip using your SDIRA, once the repairs are complete, you can get a new appraisal and refinance to pay back your SDIRA with interest.
David, what you are suggesting is incorrect and would put an investor in trouble. You can not use your IRA to fund your personal flips, this would be considered a prohibited transaction.
One problem there: it's not a "personal flip". The property is acquired in and financed by a corporation not owned by any human person. The corporation uses the IRA money invested in it to acquire and repair the proerty. The property is then refinanced and the investors (including the SDIRA) are paid out, P&I. The SDIRA now no longer has any connection and profits from the sale can be divided among the investors.
Again, I can refer you to a tax and legal expert who can explain it the same way he explains it to the IRS agents who then - by law - must allow it.
when you say "corporation not owned by any human person" what do you mean. Who owns the corporation? What is the relationship of the IRA owner to this corporation?
In your earlier post you say "Any excess becomes an advance on your profit when you sell, and the profit is then legally yours as the SDIRA has already been paid back."
This indicates that IRA account owner is indirect owner of the entity you are referring to, is my understanding correct?
Would your attorney refer to this as a "blocker corporation"? Sounds like what you are describing.
This can lower the tax rate on flipping as the corporation will pay at corporate rates which are less than UBIT.
The IRA receives dividends and or proceeds from the liquidation of shares. Both are viewed as passive income and not taxed to the IRA as a direct equity stake in a flip would.
This structure makes sense for those with a good amount of capital and a willingness to pay for quality legal services - not only for the setup but on an ongoing basis for maintenance of the entity.
This is a very different approach than most think of when discussing SDIRA plans, thus a lot of the confusion in responses to this post - which I would point out has been taken very far astray from the original inquiry posted by @Sameet Koppikar
I fully understand the transaction that you are describing per my earlier post which I agree is neither prohibited, nor subject to UBIT because the IRA is investing in a C-corporation. Many of our clients use such transaction and work with our Harvard Law educated attorney to structure it.
Phoenix, AZ · Member since 2016 · 6 posts · 3 votes
10y
Thanks Brian Eastman & Mark Nolan for clarifying. As usual on BP even the tangent discussions have been educational! I understand what I can do. Now I need to decide what to do. Thanks for your time
If you do a fix-and-flip using your SDIRA, once the repairs are complete, you can get a new appraisal and refinance to pay back your SDIRA with interest.
David, what you are suggesting is incorrect and would put an investor in trouble. You can not use your IRA to fund your personal flips, this would be considered a prohibited transaction.
One problem there: it's not a "personal flip". The property is acquired in and financed by a corporation not owned by any human person. The corporation uses the IRA money invested in it to acquire and repair the proerty. The property is then refinanced and the investors (including the SDIRA) are paid out, P&I. The SDIRA now no longer has any connection and profits from the sale can be divided among the investors.
Again, I can refer you to a tax and legal expert who can explain it the same way he explains it to the IRS agents who then - by law - must allow it.
So my personal SDIRA SD401(k) can invest in a C-Corp which has a primary business function of flipping homes - correct? How far removed from ownership/operation of the C-Corp do I need to be? Can I own and operate it? Can I do it with an S-Corp?
Don't take this the wrong way, but it seems like this strategy is designed specifically to circumvent the intent of the existing regulations. I like loopholes as much as the next guy, but I'd love to talk to a few more folks (or your IRS trainer contact) before I'd pull the trigger on this.
It's also been my experience that it's not worth the added time and expense to form entities of any kind until you get to a certain amount of annual profit. Stacking up corps like this probably sets that bar fairly high - correct?