Rental Property Investor · Potomac, MD · Member since 2016 · 115 posts · 64 votes
The way I see it, there are basically two ways to use an IRA to finance investments:
1) Have the IRA "buy" the property and ALL income and expenses are paid to/from the IRA. If financing is used in the purchase of the property, the IRA is subject to pay UBIT taxes. It really bothers me that my IRA would have to pay taxes, but perhaps the benefits outweigh this one negative.
2) Have the IRA be a private money lender and finance OTHER people's deals. You can't finance your own deals through your IRA because it would be considered a "prohibited transaction"
a) Form an investor group which lends each other money from their IRAs. If Sally lends Joe money, Joe lends Roger money, and Roger lends Sally money there are no "prohibited transactions". The investor group could either mutually agree on standard loan terms that all abide by or shop for the best terms within the group for each deal.
This is undoubtedly a simplified view on a complicated topic, but am I at least in the ballpark? Are there some other strategies that I am overlooking?
Professional · Bothell, WA · Member since 2016 · 89 posts · 17 votes
9y
@Todd Magin, Perhaps I can take a bit of the sting out of your point 1. To keep the math easy, an IRA has $100k to invest (leaving a necessary amount for expenses). You find one property for $100k. You can rent it out for $1,200 / month, net ~ 12% for the year. Instead, you find two houses at $100k and buy both using a 50% loan to value non-recourse loan on each. Rent them both out. Doubled your net income and return on investment. However, 1/2 of the funds were not your IRAs money. In this example, your IRA pays unrelated debt finance income tax (UDFI, a subset of UBTI) on 50% of the income, AND is allowed to deduct a ratio of the expenses. If you run the numbers, even after paying an income tax on the portion of income generated using non-qualified money, you are still ahead of the initial 12% total ROI. Making more money using someone else's money. Not a bad deal. Those funds do not become qualified funds just because they are loaned to an IRA, so they do not get the tax deferred treatment. Does this help?
The point I was making is that when you hold property in an after-tax fashion, the rates for lending and tax on the income earned are handled in a particular fashion, and that is very different from what one will expect in an IRA where much of the income is not taxed at all, but there are not write-offs either (vast oversimplification, it is late). The return metrics are in fact likely to be quite different for the same property held outside an IRA vs inside an IRA.
The point I was making is that when evaluating a property investment inside an IRA, it is only really meaningful to compare that investment to other investments that could be made with IRA funds, because of these differences in how the transaction is taxed.
The main exception to being able to transfer existing retirement account to the Solo 401k is the Roth IRA. Roth IRAs cannot be transferred to the Solo 401k even if the 401k has a designated Roth component. The IRS restricts Roth IRAs so much that they just cannot be transferred to anything besides another Roth IRA.
I had not considered that side of the tax consequences. If I'm following you properly, there is a negative to holding properties within an IRA in that you don't get the same write-offs (mainly depreciation) that you would get outside the IRA. Of course, you still get to defer ALL taxes within the IRA, so I look at that as a major advantage as one's available funds for investing can grow much faster if the tax man is not eating into the profits.
It is true that the IRA could invest in other more standard investments (stocks, bonds, mutual funds, etc) and the investment property must beat the pants off of these other avenues to make it worth it, but there is another thing to consider when approaching this ... YOU are in control rather than a mutual fund manager or CEO of some Fortune 500 company.
Rental Property Investor · Potomac, MD · Member since 2016 · 115 posts · 64 votes
9y
I'm sure I'm preaching to the choir, but what follows is more for those following this thread who are still not convinced that converting your IRA(s) to a self-directed IRA which invests in real estate is a good idea.
Unlike many of the other alternatives that one could invest in, real estate offers more consistent cash flow so it is much better to have in an IRA portfolio. Let's say you have $1M in your IRA and want to pull out $50K every year to live on. Therefore, you need a CONSISTENT 5% return so your funds will never be depleted. If the IRA was invested in stocks, bonds, mutual funds, you could certainly AVERAGE that over a number of years, but there may (will) be years where you actually lose money in the markets. What do you do those years? Live in a crate and eat dog food? With real estate, you get much more consistent returns (and much higher if you manage properly) so that you can comfortably pull that yearly "salary" out of the IRA while still growing it (at a lower rate because of your distributions).
I converted my old employer 401K into a PENSCO self directed IRA. I took the funds and loan it out to investors secured by a deed of trust and a promissory note. The process is that simple. Reach out if you want to share ideas or want to see how I structure my terms....
Rental Property Investor · Reedsburg, WI · Member since 2011 · 1k+ posts · 857 votes
9y
@Todd Magin I am almost certain on this, but would like one of the experts to confirm, that ALMOST any type of normal retirement fund can be rolled into both SDIRA and SOLO401K with the exception of an EXISTING ROTH SDIRA account (the kind I have unfortunately - didn't know this or I would have used regular IRA funds to start my SDIRA). This means SIMPLES, SEP, 401K etc.... are OK.
I think @Brian Eastman point is not that there is extra costs or burdens. Look at it this way; say you have 100K in 'cash' to invest and 100K in IRA or SOLO to invest - the money is ALREADY there in the retirement account.
You should NOT compare the % returns you might get on real estate that is leveraged 5:1 (20% down) in a cash deal to real estate that might only be leveraged 3:2 (40% down) in a retirement fund. The cash deal might return say 30% on investment and the retirement plan deal maybe only 15%. It sounds like less return, but they are both 6K, it is just that more down was required on one. And you also need to look at EVEN THOUGH the one 'only' makes 15% instead of 30% OUTSIDE of the retirement plan, what else WITHIN the retirement plan would make you 15% or more?
Especially when you consider the risk of fluctuation with stocks I would add. I have a nice stock that has give me a 45% annual return (about 24% compounded) over the last 7 years or so. But I know the company and watch it like a hawk. I have other that I have been lucky to average 10% over a few years. The one thing with real estate, at least where I live, is that when the economy gets bad like in the housing crisis recently rents actually stay stable or go up. As long as you have a long enough time line to ride out the dip in values it makes for pretty steady returns.
Rental Property Investor · Reedsburg, WI · Member since 2011 · 1k+ posts · 857 votes
9y
@Franklin Romine would you mind sharing what types of returns you are able to achive on average on an annual basis? Are doing shorter Hard Money Loans or more Long Term Private Money Loans?
Lending is a new experience for me. I have been a buy, hold, rehab, own and manager of property of about 40 doors. I started lending about 6 months ago, I'm on deal #3.
Deal 1 - I loaned $100K for 3 months for a flip, $7K interest balloon payment. I over funded the purchase price of around $70k to fund the rehab. Investor fixed and sold home in 2 month. 42% annual return?
Deal 2 - 2 months ago I funded a 6 month buy and hold. $80K, investor pays 1% month, interest only, $800 per month.
Deal 3 - I'm funding this week. 6 month buy and hold. $55K, investor pays 1% month, $550 per month.
I went from the first deal making a chunk of interest and now I'm just collecting 12% interest per year. Now that I understanding the mechanics my long term goal with this operation will be to keep the interest payments steady. I don't really need the capital coming back and forth to my IRA account. More transactions will create dead investment time of my capital. My goal will be to keep the capital deployed, secured a Deed of Trust and a sound Note holder, and keep steady interest payments filtering into my SDIRA. A side note is that I'm not looking to depend on this account to fund my retirement, this will be a small piece to a larger puzzle.
You are correct that the other types of retirement funds such as SIMPLE, SEP, 401k, other qualified plans, etc can be transferred to the Solo 401k. The main exception is the Roth IRA. See the IRS rollover chart here: https://www.irs.gov/pub/irs-tege/rollover_chart.pd...
Note: The Solo 401k falls under "Qualified Plan" on the chart.
I'm sorry you weren't aware of the Roth IRA restriction before getting setup. I try to make that clear to the folks I talk with since it is such big (and to many, surprising) restriction. I see it as the biggest disadvantage to a Roth IRA, but that's just my opinion.
Rental Property Investor · Reedsburg, WI · Member since 2011 · 1k+ posts · 857 votes
9y
@Justin Windham thanks for the chart for all of us to see. I admit I went into a SDIRA pretty fast as a property came up that was, and still is, a great deal for us. I did not know about SOLOs at the time.
One thing I dont understand is WHY a ROTH cant be transferred, but CAN be put in as a contribution? It does not seem like it would have a different tax collection consequnee one way or the other. Any thoughts?
You are correct, a lot of these rules don't make much sense. Yes, you can contribute Roth funds to a 401k. Yes, you can even do an in-plan Roth conversion of non-Roth assets in a 401k (if the document allows for it). But it's the completely different structure of the Roth IRA specifically that has the transfer/rollover restrictions. Note that you CAN transfer Roth 401k funds to a Roth IRA, but if you do, you'll be stuck with that format. When these structures are conceived in the minds of politicians and their colleagues, all of the surrounding facts and how the structures relate to each other are not always considered. Further, even if they were considered, many times there are opposing forces involved in getting the required acts approved and some provisions hit the cutting room floor while others are wedged in to make a particular group more likely to push the legislation through. The result is that we have some odd rules to learn and find ways to make the most of for our respective situations. At least until the rules are changed yet again.
El Cerrito, CA · Member since 2015 · 257 posts · 129 votes
9y
@Todd Magin I've been looking into purchasing out of state homes with my IRA recently and most non-recourse loans I found are 5 or 7 year loans amortized over 15 or 30 years. The best one I found was a 7yr amortized over 30 at 4.125% (this was early November). That payment after 7 years is what turned me off since I don't have that kind of cash in my account. I've been considering investing with Rich Uncles lately though.
Check out NASB and Jason Zook. I am working on two loans with him right now. A 20 year fixed on a duplex with 40% down and a 15 year fixed on a 4 plex with 40% down. Could have gone 20 year on the fourplex with 50% down but doing the math I took the 15 year.