I am considering moving my sizeable 401(k) from my previous employer to a Self Directed IRA or self directed 401(k) so that I can access the balance to use a down payments on rental properties. I've come up with the two following basic scenarios and would like to know if they are both feasible or not.
Scenario 1: I purchase a $200 duplex using $50k - or 25% down - SDIRA monies and leverage the rest. After netting income each month, I portion 25% of the net income back into the SDIRA and keep the remaining 75% outside the account. Am I able to do this or does all income have to go back into the SDIRA? What is the reasoning/code describing this?
Scenario 2 (Similar): I create an individual LLC and "invest" $50k from my SDIRA into it, purchasing 25% equity. I then purchase a $200 duplex using the $50k, which is about 25% down. After netting income each month, I pay the SDIRA a dividend equal to ownership shares (about 25%). Is this doable? If not - and likely because the LLC I create may be considered a prohibited person - is it possible/legal to utilize foreign business registrations (i.e. panama)?
Scenario 1 - This is possible, though not exactly like you describe. Your IRA can get a loan, but it must be a full non-recourse loan where the IRA is the borrower and not you. These loans are possible, though only a small number of lenders do them. They are typically more like 35-40% down. All money into the property must be from the IRA and all money earned by the property must go back to the IRA, not you. You cannot work on the property or otherwise contribute to it. I have been advised by an attorney that managing a rental owned by my IRA would be OK, but other folks think this is not acceptable.
Scenario 2 - It is possible to create an "IRA LLC", have your IRA invest in it, then you manage the LLC. Setting one of these up is a bit complicated, so you want knowledgeable legal advice. But once you do this, the same rules still apply. Were this LLC to then buy a property with leverage the same sort of non-recourse loan would be required, you cannot work on the property, and money must come from the IRA LLC and earnings must go back to the IRA LLC.
In either scenario you absolutely cannot have the IRA provide a down payment and then you get a loan. More generally, your IRA cannot do anything that would in any way benefit you personally. Its not that the IRA or IRA LLC is a disqualified party. Rather its you that is the disqualified party. Any transaction between you and the IRA is a prohibited transaction.
You cant personally work on it, but you can have outside contractors work on it. no "sweat equity"
from what I understand.
@Jon Holdman Thanks for the detailed answer Jon. I've done some more intense research and managed to weed through a lot of the conflicting online information. Seem you are correct on all accounts. Best rule of thumb seems to be "if it benefits a 'disqualified person' IN ANY capacity, it is not allowed. Thanks again.
Larry, your understanding in your latest comment is correct: as a disqualified person you are not allowed to benefit from your IRA (directly or indirectly), or provide any good, services or facilities to your IRA. All transactions involving your IRA must be 'arms length'.
In a short while, BP has given you some good answers.
Back to the basic, goal, which is taking the existing savings and getting better results by investing in real estate. That is very much possible - albeit with some pretty significant readjustment of your expectations.
A self-directed IRA or 401k is not a way for you to access the tax-sheltered money in your retirement plan for your investments. Rather, it is a way to diversify the tax-sheltered retirement savings into assets such as real estate.
Continue researching and get on the phone with some professionals in the field. If you believe that investing in what you know will produce better results, there is a way to get there.
@Larry Hawkins here is a thought. If you plan on putting 50k down why not take out a loan on your Solo K and use that outside your plan? That way you could work on it yourself if you choose to do so and also pay it back with the 25% income.
You will most likely need to discuss this with your tax attorney as there is a way to accomplish what you are trying to do but very specific rules apply.
I don't think using SDiRA for buying rentals is a good idea. Rentals are already tax advantaged in so many ways there is no benefit to putting them inside the IRA and having all the additional hassle along with it. You could still invest in read estate by putting the SDIRA into private lending or notes or tax liens or other forms of investments that are taxed as income and the iRA provides the tax shelter.
In either a SDIRA or SD401k you can personally borrow money from the account as a loan to you. Difference is the amounts and time frame. With 401k you can borrow up to 50k or half your total amount and make a loan to you at a rate you get to pick payable over 5 years. IRA can do unlimited amount but must be paid back in 60 days. I put together a comparison of the two (others correct me if i'm wrong on any of it) here. By lending the money to yourself you should be able to acquire the loan in your name and you just make your payments back to the IRA/401k you borrowed from.
I recently set up my sd401k and I'm happy with IRAFinancial handling the process. Did have to go through a unique bank to set it up the way I intend to manage the funds. In either of your cases the funding should be available if you're set it up correctly with a company that provides and understands this strategy. Its just a matter of finding the ones who want to play those rules; not that they are questionable but they don't make commission when you manage the money yourself.
In both cases you'll need to keep things at an arms length transaction meaning no benefits for immediate family, yourself, and some other requirements. Now where it does get gray for me is when you lend money to yourself (say that 25% down payment) and get a loan for the remaining 75% to purchase a property you do intend to work on/live in. My guess is this would be considered non-arms length, but I would ask the pros on that.
Steven, IRS rules do not allow loan to yourself from an IRA. "60 day loan" you are referring to is not a loan. Rules allow for 60 days rollover, using that as a "loan" to self can be dangerous and is not what this is intended for. If you are one day late depositing those funds into qualified plan it will be treated as a distribution with applicable taxes and penalties.
@Dmitriy Fomichenko Thanks for the heads up on this one! I'll look into that more.
To learn more about the 60 day rollover rule, see the following:
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