Properties in SDIRA, good or bad?

Question

Often a Self Directed IRA (SDIRA) is presented as a better retirement and/or investing vehicle, especially for its ability to invest in real estate. This is actually one of the main points in the sale speech of many SDIRA custodians and administrators. However, a few tax advisers (some famous, like Gary Sutton) consider purchasing real estate properties (a tax advantaged asset) within a SDIRA (a tax advantaged account) a bad proposition, on the idea the two of them nullify each other and lose the tax advantages (like depreciation).

Therefore, I'm looking for people with experience with SDIRA's and using them for real estate investing - is it a good strategy or not? Should you get rental properties with your SDIRA? With or without leverage, through non-recourse loans and the potential UBIT? Should we look into notes only, and stay away from properties in SDIRA? Does it make a difference if investing with a IRA SDIRA or a ROTH-IRA SDIRA?

Note: I'm primarily a buy&hold investor, primarily interested in the cash flow and passive income (and tax advantages) rental properties provide and not so much in the appreciation promise, with a very long outlook (current exit strategy is to pass them to our heirs).

Brian Eastman · Answer

@Costin Iorgulescu

While there is technical merit to the differentiation between the tax performance of passive real estate held personally and within an IRA, the argument misses the key point.

When investing your IRA in any asset, you are not comparing that investment to how it would perform in the after-tax world.  The tax situation is entirely different, and it is therefore an apples-to-oranges comparison.  The only sensible comparison is how an asset/opportunity compares to other investments you might make with the IRA.

If you understand an asset class such as real estate (or private lending, or venture capital ...) and can get better results for your IRA by investing in what you know, then a self-directed IRA makes sense.

Daniel Dietz · Answer

@Costin Iorgulescu,

I think you got some good responses above. More to your specific questions though.....

I own property both traditionally outside of retirement accounts and inside of SDIRAs and SOLO401Ks (better IF you qualify).

For rentals outside of Self Directed accounts we are able to get returns of approximately say 15-20% when figuring equity building and cash flow - this is with loans of 20% down-payment. Certainly better than traditional equities over the long run and more stable too, in my opinion. There is the positive cash flow while having a tax loss benefit too consider with this method, but if you 'buy and hold forever' (somewhat our plan also) there comes a point where with rising rents and declining interest payments when that tax loss benefit goes away. That looks to be around the 10-12 year point on our 25 year amortization.

For the rentals inside of the Self Directed accounts we are able to get returns of about 9-12 percent if not using leverage or 12-15 percent when using leverage with 40% down. Also note that if you does use say 60% leverage, you also get to deduct 60% of the depreciation. So the choice inside of retirement accounts is "do I invest in securities and get say 8-12 percent with a roller-coaster at times, or real estate where I can get 12-15% with very little volatility"? To me, for funds already in retirement accounts, it is a no brainer.

A couple of the benefits of holding rentals inside of retirement funds vs stocks is that you can essentially use leverage which you are not allowed to do when buying securities.

You also need to remember that even though you get the 'temporary' benefit of depreciation, you will have to pay that back, at a 25% rate, some day unless you do indeed pass on to heirs down the road.

A couple of other 'side benefits of hold in retirement accounts are that in general those accounts are more protected in bankruptcy or lawsuit cases, and if a person has college aged kids assets in retirement accounts are not counted towards financial aid calculations in many cases (but not all).

One of the reasons  we (myself and 2 partners) bought as much as we did with retirement accounts was because we all already had sizeable assets in those accounts that we rolled over to fund our SDIRAs and SOLO401Ks. Moving forward we plan on putting very little new funds into those accounts and directing new funds towards cash purchases of rentals.

Hope that helps your thought process a bit.

Dan Dietz

Brian Eastman · Answer

@Costin Iorgulescu

As I noted, if investing in rental property will produce better results in terms of risk/reward than continuing to invest in the stock market only, then it is the right move.

There is no apples-to-apples comparison between you personally investing in real estate and your IRA investing in real estate, just as comparing you investing in stocks with personal funds would also be very different from you investing in stocks with your IRA.  That is exactly my point.  The only real comparison is "can my IRA do better investing in real estate than what it is invested in today?"

There is no one right answer.  It is all situational.  We have many thousands of clients holding rental property in their IRA accounts who are very pleased and getting good results.  We have also had a handful of clients over the years make bad investment choices in real estate - either through lack of experience, picking the wrong partners/providers, etc.

The bottom line with a self-directed IRA is that you are your own "fund manager" so to speak.  You can design the portfolio that best suits your expertise, network and goals.

Costin I. · Answer

@George Blower Did you even read my question/post?

Brian Eastman · Answer

@Tom Burns

The are two easy solutions to the liability issue you note:

Option 1 would be to have a self-directed IRA with the $100K property and a separate IRA at a conventional brokerage.  Those are two separate entities and a judgement against the self-directed IRA would be very hard pressed to go after the other IRA.

A more robust option 2 would be to use a Checkbook IRA LLC.  Have the $100K self-directed IRA invest into a LLC that is then used to purchase the rental property.  Now that property is isolated within the limited liability buffering of the entity.

Tom Burns · Answer

For my SDIRA, I write paper and do equity participation deals with flippers.  Don't own any property in it at all.  Owning rentals in an IRA and titling them as your IRA, to me, could open your IRA up for liability.  Example: You have $500K in your IRA, buy a $100K rental with IRA funds and title it with your IRA (so you now have $400K cash in the IRA and the $100K house).  Renters have a party, outside deck collapses, somebody gets hurt.  Even though you have insurance, you could possibly be jeopardizing the other $400K in your IRA since it and your house both have the same name and an attorney could go looking for whatever funds he can get for his client....

George Blower · Answer

@Costin Iorgulescu

Investing an IRA in real estate is another way of growing your IRA by not just investing your IRA in equities. It is another way of diversifying your IRA investments.

Costin I. · Answer

I'm not that familiar with private lending or venture capital, so my compare point is what I'm currently doing - rental properties. Investing in lending or venture capital, that would definitely be an apples-to-oranges comparison.

So, how can I bring rental properties investing to an apple-to-apple comparison ?

And do you subscribe to the idea of SDIRA investing in properties as good strategy or bad strategy?

Properties in SDIRA, good or bad?

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