What are you investing in with your IRA?

Tax, SDIRAs & Cost Segregation
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What are you investing in with your IRA?

Lue C.
Cary, NC · Member since 2017 · 41 posts · 14 votes

I have been researching REI with IRA money. Here are some of my thoughts, and I would love to hear what you think? More importantly, what are you investing with your self directed IRA and why.

There are many tax benefits for investing in real estate - deduction, depreciation, 1031 exchange and etc. The idea is to keep "kicking the can down the road" - keep delaying paying taxes while utilizing the profits now - living off the cash flow or investing. Let me just use rental property as an example. If my net income from a rental property is $5000 last year, I can work with my tax adviser to use depreciation to "write off" that income. To the IRS, my LLC could have operated on a negative income for 2016, so I can pocket the whole $5000 without paying tax last year. I understand I need to pay tax when I sell unless I do a 1031 exchange, but let's just focus on 2016 for now.

If the same rental property is owned by my pre-tax IRA account, does it mean I can't do any of the write off? My IRA will just grow $5000 in 2016, and I will pay tax when I withdraw the money after age 59? Will these $5000 be taxed on capital gain rate (15%) or my income bracket at the time of withdrawn?

Or, is it better to use the pre-tax IRA to invest in notes and tax liens where we don't get tax benefits, and use cash to invest in rental properties and syndication deals that can utilize tax benefits? What about Roth IRA - which niches to invest with already-paid-tax IRA?

What are your thoughts?

Lue

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Daniel DietzPro Member
Rental Property Investor · Reedsburg, WI · Member since 2011 · 1k+ posts · 857 votes
9y

I just wanted to throw this out there for those of you thinking about if a SOLO401K might be a good fit for you AND you already have lots of funds in a 401K where you are leaving a job or a non self directed IRA.

Even if your 'self employment income' is small, say you do 5K worth of consulting or contracting 'on the side' to your regular w-2 job. You might me thinking "it will take forever to build up enough to invest". That would be true if all you did was contribute, BUT you can also 'roll-over' many kinds of plans into a SOLO401K (except ROTH, I learned the hard way with that one :-( ).

So, if you have say 100K in an IRA, but only make 5K from your self employment work, you can roll that 100K over AND contribute a few thousand of your SE income, and you have plenty to invest with. One of my partners just set theirs up using almost this exact scenario. I have a friend that is considering starting to do some 'side work' just to be able to qualify for a SOLO401K and then roll his sizeable nest egg over and start buying rentals with that.

Dan Dietz

[email protected]608-524-4899
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  • Jay Orlauski
    Realtor · Fresno, CA · Member since 2013 · 471 posts · 225 votes
    9y

    This is for sure a tax related question - but from what I understand about it is that because it is already tax deferred , that you cannot take deductions for losses from it.  That needs to be verified - Karaan Hall does a really good discussion on the topic: 

    https://www.youtube.com/watch?v=xL6H4KLg1jc

    There are a lot of advantages to using SD-IRA's - most investors use multiple tax strategies to invest though and the SD-IRA is simply one of them. It all depends on how much income you're making now, how much you intend to be making in retirement and how you can best use your current resources, and what your plans for the future are.

    One example given is that outside of your SDIRA - if you sell a property , it is immediately subjected to taxation to the tune of 20% or so - that means you only have 80% of that money available to invest into another property - of course you can do a 1031 exchange to defer the taxes - but doing a 1031 exchange is not always that easy - there are certain restrictions and time limits that you have to adhere to or you wont be able do it properly - you have to identify your subject property within 45 days and many investors will identify multiple properties so that if they don't get the offer accepted on one - then they have others to fall back on - if you cant find another property quickly - then you may not be able to 1031 it. In the SD-IRA you can sell your properties at any time without worrying about any time frame to reinvest the money - That's just one example of how it would benefit you vs a 1031.

    Check out the video if you haven't already - it is a little long , but very informative

    best of luck to you - 

    0Reply
  • Daria B.
    Rental Property Investor · Gainesville, FL · Member since 2015 · 1k+ posts · 432 votes
    9y

    @Lue C. I am investing in notes using both SD (IRA and Roth). I found it to be the easiest to utilize my money.

    1Reply
  • Lue C.
    OP
    Cary, NC · Member since 2017 · 41 posts · 14 votes
    9y

    @Daria B.  Thank you for responding.  I feel the same way too.  May I ask how you are investing with notes?

    0Reply
  • Daniel DietzPro Member
    Rental Property Investor · Reedsburg, WI · Member since 2011 · 1k+ posts · 857 votes
    9y

    @Lue C., 

    If you do a search on the back posts here, you will find a LOT of different opinions on this as you could imagine ;-) 

    I admittedly dont know hardly anything about Notes, so have thus far have avoided them. 

    With that said, I look at it purely as 'where can I get the best return for the risk incurred'. Meaning if I can get say 12% return in Notes or Private Lending, or an 18% return in rentals, I would pick the rentals! 

    To me, it does not really matter that in *some* cases, you will miss out on the depreciation benefit. Example would be a rental that I leveraged by putting 40% down (leveraged at 2.5 to 1). Lets say I get an 8% cash on cash return. Lets assume an average loan pay down of 2% * 2.5 leverage = 5% additional. Then we have appreciation of 2% * 2.5 leverage = 5% for a total of 18%. All of these figures are towards the conservative side in our small town market. 

    As was mentioned above these gains grow tax deferred or tax free depending on what kind of IRA you have. A side note is that you CAN take depreciation in if you are using leverage since there may be some UDFI taxes due. There are also ways in some cases where you can do a 1031 Exchange even within a IRA.

    One other  side note is that IF you are eligable for a SOLO401K (self employed) there are a LOT of benefits to it. I learned the hard way and am working on moving funds from a SDIRA to a 401K as we speak. A couple of side benefits are usually no UDFI tax due on leveraged funds and MUCH higher contribution limits also. 

    Dan Dietz

    [email protected]608-524-4899
    2Reply
  • Edmund Ricker
    Gorham, ME · Member since 2016 · 224 posts · 116 votes
    9y

    @Lue C.

    I am investing in private lending with my SDIRA.  I plan to do this for a few years as I build up the amount of capital to the point where I can include real estate if I choose.

    There are many options you can choose from for private lending. Try networking with your local REIA group and see what connections you can make. There are also websites that specialize in matching investors and borrowers such as Propser.com and LendingClub.

    Hope this helps.

    Ed

    0Reply
  • Lue C.
    OP
    Cary, NC · Member since 2017 · 41 posts · 14 votes
    9y

    Thank you all for your comments.

    0Reply
  • Paul Caputo
    Cost Segregation Specialist · Naperville, IL · Member since 2016 · 204 posts · 168 votes
    9y

    When using an IRA you don't get depreciation. Your Tax basis in the IRA is $0, so your tax basis in the property would also be $0. The IRS generally doesn't let you have your cake and eat it too. You only get depreciation because you paid for the property (cash or financed doesn't matter) and can't expense it all at once since it has a useful life over one year. Using tax deferred or tax free funds means you already have tax benefits on these funds so you don't get further tax benefits on them.

    As @Daniel Dietz points out you can still make it work quite well without depreciation if you set it up correctly. 

    0Reply
  • Dave Van HornPro Member
    Fund Manager · Wayne, PA · Member since 2009 · 1k+ posts · 1k+ votes
    9y

    A lot of great info above.

    @Lue C. Personally with my SDIRA, I currently invest in notes, shares of companies, and I even co-own a stock fund that day trades. I also do hard money/private money as well.

    I love my IRA but I also think you don't have limit yourself with just these types of accounts, there are other comparable vehicles to consider (many times with fewer rules) such as insurance contracts for example.

    Best,

    Dave

    Podcast Guest on Show #273
    1Reply
  • Daria B.
    Rental Property Investor · Gainesville, FL · Member since 2015 · 1k+ posts · 432 votes
    9y
    Originally posted by @Lue C.:

    @Daria B.  Thank you for responding.  I feel the same way too.  May I ask how you are investing with notes?

     I am buying 1st non-performing notes, some are BK13.

    0Reply
  • David Thompson
    Investor · Austin, TX · Member since 2013 · 933 posts · 1k+ votes
    9y

    Lue,

    You got it right, investments that aren't tax efficient (such as interest bearing investments) should be positioned inside your qualified accounts (SD-IRAs).  Those that are tax efficient such as rental property, syndications invested in commercial real estate, should be in taxable accounts (non qualified).  This is if given the choice and you have ample money in both areas. 

    Daniel Dietz makes some excellent addtional points. If no choice and you decide to put leveraged RE into your SD-IRA, you will likely be faced w/the UDFI tax on the leveraged portion of the investment at time of sale. Solo 401K have some additional advantages that if you haven't looked into it should be explored besides higher contributions and that includes no UDFI impact.

    0Reply
  • Justin WindhamPro Member
    Banker · Nationwide · Member since 2015 · 4k+ posts · 1k+ votes
    9y

    @Lue C.

    If you have self-employment activity, you may want to consider a Solo 401k instead of an IRA.

    Contributions limits are roughly 10x higher, there is no custodial requirement for the 401k, you can take participant loans, you don't need the additional expense and administration of an LLC to have checkbook control, there is a built in-Roth component, a spouse can participate, there are additional tax benefits (UDFI exemption), there is generally greater privacy, and the plans are often quicker to setup and cost less money over time especially compared to most IRA LLCs.

    1Reply
  • Lue C.
    OP
    Cary, NC · Member since 2017 · 41 posts · 14 votes
    9y

    @David Thompson

    Thanks for your comment.  How is syndication invested in CRE, like apartment building tax efficient?  I don't think you can do a 1031 exchange when the asset is sold at the end of the project to shelter the big junk of (hopefully) gain from the sale.  I understand you can do accelerated depreciation to offset the positive cash flow each year.  However, I am not sure what kind of tools or techniques that can shelter the gain upon sale at the end of the project.  Any advise?

    0Reply
  • Sam Shueh
    Real Estate Agent · Cupertino, CA · Member since 2016 · 4k+ posts · 1k+ votes
    9y

    When you lose an investment say a note in default, you lose both the note and retirement money for good.

    0Reply
  • Daniel DietzPro Member
    Rental Property Investor · Reedsburg, WI · Member since 2011 · 1k+ posts · 857 votes
    9y

    I just wanted to throw this out there for those of you thinking about if a SOLO401K might be a good fit for you AND you already have lots of funds in a 401K where you are leaving a job or a non self directed IRA.

    Even if your 'self employment income' is small, say you do 5K worth of consulting or contracting 'on the side' to your regular w-2 job. You might me thinking "it will take forever to build up enough to invest". That would be true if all you did was contribute, BUT you can also 'roll-over' many kinds of plans into a SOLO401K (except ROTH, I learned the hard way with that one :-( ).

    So, if you have say 100K in an IRA, but only make 5K from your self employment work, you can roll that 100K over AND contribute a few thousand of your SE income, and you have plenty to invest with. One of my partners just set theirs up using almost this exact scenario. I have a friend that is considering starting to do some 'side work' just to be able to qualify for a SOLO401K and then roll his sizeable nest egg over and start buying rentals with that.

    Dan Dietz

    [email protected]608-524-4899
    2Reply
  • Justin WindhamPro Member
    Banker · Nationwide · Member since 2015 · 4k+ posts · 1k+ votes
    9y

    @Daniel Dietz

    You made some great points. I'll add a couple items - while you cannot transfer Roth IRA funds to the Solo 401k, if you have Roth 401k or other qualified plan funds, those can be transferred to a Solo 401k.

    As far as creating self-employment activity, there is no minimum amount of work or income that is required. However, the self-employment activity must be legitimate, and the intention to make contributions from that self-employment income should be present as well. Then folks can enjoy all the benefits the Solo 401k offers.

    0Reply
  • Lue C.
    OP
    Cary, NC · Member since 2017 · 41 posts · 14 votes
    9y

    @Daniel Dietz, @Justin Windham - Great tips! I should start thinking about doing some side job to qualify a solo 401K. What about a rental business? I have a rental property owned by a LLC, which my wife and I own. If the LLC pays me, the manager, a salary to manage the business, can my wage from the LLC be considered my side income, which will qualify me for a solo 401K? I better talk to account/tax adviser soon!

    Lue

    0Reply
  • Justin WindhamPro Member
    Banker · Nationwide · Member since 2015 · 4k+ posts · 1k+ votes
    9y

    @Lue C.

    While rental income is generally passive, some people do indeed have at least a portion of income from real estate investing that may be earned income. You are absolutely correct in getting in touch with a qualified tax adviser. They can educate you on the difference between passive income and earned income. You may have earned income if the activity you provide in generating the profits is extensive or time consuming. Common examples are short term rentals, repairs, rehab, flipping, etc.

    0Reply
  • Daniel DietzPro Member
    Rental Property Investor · Reedsburg, WI · Member since 2011 · 1k+ posts · 857 votes
    9y

    @Lue C.,

    I am not sure on the 'rental business' so I will let others comment on that.

    In my friends case, he is a carpenter and works for a large company for his 'day job'. On and off over the years he has done 'side jobs'. He is going to start doing this again. In our area he can easily pick up small handyman jobs from $40-$50 an hour. He is figuring if he works a dozen Saturdays a year he should be able to pick up about 5K a year, so call it 4K after expenses; gas, tools, etc.... 

    Does your current profession lend itself to this? Or do you have other skill sets that you could expand on?

    Dan Dietz

    [email protected]608-524-4899
    0Reply
  • Lue C.
    OP
    Cary, NC · Member since 2017 · 41 posts · 14 votes
    9y

    @Daniel Dietz Good point.  I am a computer programmer so I am good with computers and making website, which can definitely lead to consulting business.  I will certainly explore that.  But this is outside of this post.  Thanks for the direction though.

    0Reply
  • Account Closed
    Investor · West Los Angeles, CA · Member since 2014 · 230 posts · 239 votes
    9y

    Private lending

    0Reply
  • Paul B.
    Rental Property Investor · Dallas, TX · Member since 2015 · 503 posts · 504 votes
    9y
    Originally posted by @Sam Shueh:

    When you lose an investment say a note in default, you lose both the note and retirement money for good.

    Why? An IRA can't foreclose on the property?

    0Reply
  • Paul B.
    Rental Property Investor · Dallas, TX · Member since 2015 · 503 posts · 504 votes
    9y

    I've been exploring a SD IRA too, or potentially a Solo 401(k), which is better for my primary investment vehicle (leveraged multi-family passive investments), but I am not self-employed, so I may not qualify to start one.

    My impression was that a SD IRA makes sense for transactions where you might get taxed as regular income, such as lending. If you are buying and selling properties where you might be subject to capital gains taxes, it might make more sense to do it outside an IRA, or possibly with a Roth IRA, because capital gains tax rates are much lower than income tax rates, and any money you withdraw from an IRA is going to be taxed like regular income.

    But, then I started doing some math, and the difference may not be so clear after all....

    For example, buy a $100,000 house in cash, and in two years you sell it for $150,000. If you do it in an IRA, you're going to pay income tax on all $150,000 when you withdraw after the age of 59 1/2. That's $37,500 if you're in the 25% tax bracket.

    If you do it with cash that wasn't in an IRA, you're only going to pay capital gains tax (15%) on the $50,000 profit, or $7,500. At some point, you paid $33,333 in taxes on $133,333 in earnings just to have that $100,000 in cash (again, 25% tax bracket). That's a total of nearly $41,000 for the same transaction.

    It seems that the best approach would be to do it in a Roth IRA. You'd still pay $33,333 in taxes to get that $100,000, but you'd never pay the capital gains tax as long as you withdraw after 59 1/2.

    I only started exploring this recently. Do I understand it correctly? I imagine that everyone's situation is so different that there is no obvious choice. I think for a lot of people, investing with an IRA makes sense because it's their only way to access capital that they wouldn't otherwise have.

    0Reply
  • Franklin Romine
    Visalia-Fresno, CA · Member since 2009 · 1k+ posts · 863 votes
    9y
    I transferred the funds from my ex day 401k account into a Pensco Self Directed IRA.... to loan money out secured by real estate. So far so good. Franklin
    0Reply
  • Mike ReynoldsPro Member
    construction · Nacogdoches, TX · Member since 2011 · 2k+ posts · 1k+ votes
    9y
    Originally posted by @Paul B.:

    I've been exploring a SD IRA too, or potentially a Solo 401(k), which is better for my primary investment vehicle (leveraged multi-family passive investments), but I am not self-employed, so I may not qualify to start one.

    My impression was that a SD IRA makes sense for transactions where you might get taxed as regular income, such as lending. If you are buying and selling properties where you might be subject to capital gains taxes, it might make more sense to do it outside an IRA, or possibly with a Roth IRA, because capital gains tax rates are much lower than income tax rates, and any money you withdraw from an IRA is going to be taxed like regular income.

    But, then I started doing some math, and the difference may not be so clear after all....

    For example, buy a $100,000 house in cash, and in two years you sell it for $150,000. If you do it in an IRA, you're going to pay income tax on all $150,000 when you withdraw after the age of 59 1/2. That's $37,500 if you're in the 25% tax bracket.

    If you do it with cash that wasn't in an IRA, you're only going to pay capital gains tax (15%) on the $50,000 profit, or $7,500. At some point, you paid $33,333 in taxes on $133,333 in earnings just to have that $100,000 in cash (again, 25% tax bracket). That's a total of nearly $41,000 for the same transaction.

    It seems that the best approach would be to do it in a Roth IRA. You'd still pay $33,333 in taxes to get that $100,000, but you'd never pay the capital gains tax as long as you withdraw after 59 1/2.

    I only started exploring this recently. Do I understand it correctly? I imagine that everyone's situation is so different that there is no obvious choice. I think for a lot of people, investing with an IRA makes sense because it's their only way to access capital that they wouldn't otherwise have.

    I'm not a tax man by any means but (I think) you examples are comparing apples and oranges. If you bought the house in your IRA for 100k and sold it for 150k yes you pay tax on the whole lot. But remember that you were never taxed on the original 100k in the first place.

    If you bought it with cash then that first 100k was taxed income. You paid the tax before you bought it. Assuming it was w2 income. If not you would pay that tax in April of the next year. Therefore, you pay tax on the gains only. 

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