Self directed: active or passive management of rentals

2 Replies

Hi all, although not new to investing (over 200+ properties since 2000) I am new to self directed retirement plan investing. It is my understanding when investing in rental properties, both long term and vacation rentals, the properties should not be managed by me personally as that would make it an active investment and subject to income tax versus a passive investment managed via a management company. If i am correct on that, how distant does the management company need to be? Could I utilize a management company owned by a family member? Could I open a management company under a new LLC, charge market rates and pay income taxes on any income produced by that company?

I love the BP family and resources, only wish it was around when I first started.

Thank you all.

Pete

@Pete Torrez

Firstly, your understanding of the situation is incorrect.

The active/passive distinction you are referring to has to do with the nature of how income to the IRA is generated. Passive income such as rents from real property, interest, royalties & dividends is fully tax-sheltered to an IRA. When a tax-exempt entity such as an IRA engages in a trade or business on a regular or repeated basis, however, then there are taxes that apply (UBIT) meant to protect tax-paying businesses from unfair competition.

So, rental property in an IRA should be fully tax-sheltered. The use of leverage may change that but not in a significant way and something to cover separately.

The distinction you are making about property management is important, but has to do with compliance. You or a disqualified party to your IRA (lineal family and businesses owned by you or lineal family) may not benefit from or provide benefit to the IRA. This would violate the self-dealing rules surrounding IRA plans.

The IRS rules are not in specific black and white on the topic of managing real estate held by an IRA. If you want to ensure 100% total compliance, hiring an unrelated 3rd party to manage properties would be wise. There is a very common interpretation in the legal community that you may administratively self-manage, so long as you do not cross a line of providing services to the IRA. So, signing a lease, paying the bills and receiving the rents for a reasonable number of doors should be OK. Do not perform sweat equity, or hire a company you or close family own to perform services.

Brian, thank you for taking the time to respond to my post.  Your response was very helpful and has also opened the door to some additional questions that I will tackle as time permits.  Again thank you and the rest of the BPs community.