How to invest in rental properties with a Roth IRA

24 Replies

Hi all, 

While in college I worked fulled time at a fortune 500 company. I was able to put away a good amount in my 401k in the two years I have been at the company. I am now leaving the company and am going to roll my 401k into a tradition pre-tax IRA and then a self direct post tax Roth IRA.

I am moving most of my money into more conservative investments in the economical environment we are in. 

I am wondering if anyone has information on how to invest in real estate rental properties with a Roth IRA. I have heard you have to hold your money with a 3rd party and besides that you can pretty much just use the money to invest.

I wanted to get peoples thoughts and if anyone knows someone that specializes in this area. I live a little North of San Francisco so someone close to that area would be great.

@Dylan Mathias

In order to invest in alternative assets such as real estate, you need to establish a self-directed retirement plan.  Such plans are offered by specialty firms and not handled by mainstream stock brokerages.

If you are self-employed and have no full time employees, a Solo 401(k) is the most flexible option. You would need to set that up and rollover your funds as tax-deferred status, and then convert to Roth inside the plan, as a 401(k) cannot accept a rollover of Roth IRA funds.

In the IRA space you can work with a 3rd party custodian as processor, or push the custodian to the back end and have the IRA invest into a specialized LLC. This latter structure is referred to as a Checkbook IRA LLC.

There is lots of good information on these plans here on the forums.

In all cases, investments in real estate are purely a diversification play for the tax-sheltered retirement plan. You can administer investment, but you may not benefit personally in any way (other than growing your retirement savings) nor may you inject value into the IRA/401(k) via the provision of services.

@Brian Eastman

Thank you Brian. This information was extremely helpful. After doing a little research it looks like the Checkbook IRA LLC is what I have been wanting to do.

Just to summarize what I would do, is take my money from my employer 401k once I leave roll that into a pre-taxed IRA. Then from there into a Roth IRA.

After this create an LLC. Assign the Roth IRA as the passive investor of the LLC and assign myself personally as the manager that will not be compensated.

I would open a bank account using the EIN number after establishing the LLC.

From there I can invest in real estate and manage all the inflows and outflows through the LLC without commingling money with your personal assets.

Is this about right?

My last questions is if I used those funds in my Roth IRA as a down payment and got a loan how would that work? I am assuming that would complicate things for tax reasons.

@Dylan Mathias

Yes, it sounds as if your understanding of the IRA owned LLC structure is correct.

An IRA may borrow, but the debt instrument must be non-recourse, meaning no personal guarantee from you. The use of debt-financing in an IRA generates taxable income to the IRA in the form of Unrelated Debt-Financed Income. That means there is a small tax on the portion of the gains the IRA receives as a result of the use of the non-IRA (borrowed) money.

While somewhat more complicated, and definitely a space where you want a tax expert on your side, the use of leverage can significantly boost your cash-on-cash returns.

@Brian Eastman

Brian I really appreciate your time. Does your firm have the ability to assist in a process similar to this if I decide to move forward with it? 

So ultimately you can put up the the real estate investment you buy through the Checkbook LLC as collateral but you cannot put up anything else to get a loan.

Dylan - I did a significant amount of research on custodians and providers and chose Polycomp. They are out of Roseville and a great mix of high service level and reasonable fees. Equity Trust out of Ohio is the big gorilla in the space. Their marketing is excellent and very informative. 

I decided not to do the checkbook IRA because I was advised the IRS doesn't have a declarative position on it. I know many people do it and I think the probability of an issue is small but disqualifying the account would be very costly for me.

It turned out for my overall strategy, I didn't really need the flexibility of the checkbook IRA. I decided to only include ultra passive investments that didn't have a depreciation component (since that doesn't help in the tax advantaged accounts) into my SDIRA so no need for checkbook/LLC.

Polycomp and Equity Trust are easy to find but let me know if you need contacts or information.

@Dylan Mathias

@Brian Eastman taught you well as your understanding is very good. I personally do not like you being the manager of your IRA checkbook LLC as @Dave DeMarinis noted. The case law establishing checkbook IRAs is Swanson vs IRS and is a weak precedent but many people use them. Our clients do it both ways however, I would have your attorney work with your provider so you have a plan if Swanson gets overturned. It may be as simple as abandon the LLC and return the assets to the administrator/custodian for your IRA. Good luck and if I can help in the future let me know. 

I would lend or flip in an IRA, but not hold. Holding can create great tax benefits for us with depreciation that IRAs can't utilize. They also appreciate tax-favored if held more than 365 days and your heirs inherit at a stepped up basis eventually and you can 1031 exchange along the way anyway.

Lending and flipping earn ordinary income, so definitely a benefit to having an IRA coat over, just like using IRAs to hold securities that create tax events for us like REITs and MLPs.

Hold long-term tax advantageous assets outside of your IRA. If that's the only place you have money, that's a symptom of larger things. Don't hold inside an IRA.

@Steve Vaughan

As of now about 60% of my net worth is in retirement accounts. I was fortunate to work at a company during college that had around a 50% match on their 401K so I took advantage of that. I am now 24 and am starting my own company and besides my yearly Roth IRA contributions I will be keep everything outside of my retirement accounts for awhile.

With that being said I would only do this process if we have a huge correction in the market. I believe more in buy and hold but also see where you are coming from with utilizing the instruments that get taxes at the ordinary income in the tax sheltered account. I live in Northern California where if you get in at the right time there is very good appreciation. I am just trying to figure out ways I can maximize my money if tomorrow there is a huge correction in the market so I can take advantage. 

I really do like the 1031 (defer, defer, defer, die) method where you can defer taxes until you die and then your heirs get the new cost basis and don't have to pay taxes. 

Originally posted by @Dylan Mathias :

@Steve Vaughan

As of now about 60% of my net worth is in retirement accounts. I was fortunate to work at a company during college that had around a 50% match on their 401K so I took advantage of that. I am now 24 and am starting my own company and besides my yearly Roth IRA contributions I will be keep everything outside of my retirement accounts for awhile.

With that being said I would only do this process if we have a huge correction in the market. I believe more in buy and hold but also see where you are coming from with utilizing the instruments that get taxes at the ordinary income in the tax sheltered account. I live in Northern California where if you get in at the right time there is very good appreciation. I am just trying to figure out ways I can maximize my money if tomorrow there is a huge correction in the market so I can take advantage. 

I really do like the 1031 (defer, defer, defer, die) method where you can defer taxes until you die and then your heirs get the new cost basis and don't have to pay taxes. 

I wish I was where you are at 24. Well done, Dylan!

As long as you know what you're getting into holding inside an IRA. No depreciation, lots of rules. I've heard many that didn't understand that going in and regretted holding. Cheers!

@Steve Vaughan

Thank you Steve. I have had very good role models in my life that I have to contribute most of it too. If you were in my shoes would you just leave the money I have accumulated in retirements fund in stocks, bonds and mutual funds and forget about it? Then just use my liquid assets to buy real estate. 

I could also very well do fix and flip with that money. I have a lot of good friends that are contractors. 

I get mixed answer from people. Some say you should either be a buy and hold or fix and flip investor. I like the idea of doing both but what are your thoughts on this?

Originally posted by @Dylan Mathias :

@Steve Vaughan

Thank you Steve. I have had very good role models in my life that I have to contribute most of it too. If you were in my shoes would you just leave the money I have accumulated in retirements fund in stocks, bonds and mutual funds and forget about it? Then just use my liquid assets to buy real estate. 

I could also very well do fix and flip with that money. I have a lot of good friends that are contractors. 

I get mixed answer from people. Some say you should either be a buy and hold or fix and flip investor. I like the idea of doing both but what are your thoughts on this?

 A lot of investors do both, b&h and flip. For me it depends on the property. Higher end doesn't generally make a good rental, so I'll flip or wholesale. I don't wholesale/wholetail much, but have done a few that were nice but too skinny to flip.  I have a list of retail buyers and their criteria.  When I come across a nicer place with only 30-50k of equity, I run it by my owner-occ hopeful or upsize list. Previous/current tenants, insurance & banking people, box store workers, contractors, gym buddies, lots of folks looking for their first home or added/got rid of a child and want a larger/smaller one. Should have been a realtor LOL.

I may establish an SDIRA for a flip that comes up, but I wouldn't hold inside it. I would keep most in paper securities and let it grow. You have 35+ years! Convert to a Roth (all or part) when you have a lower income year.  I've been funding a traditional the last few years because of my tax position, then will convert in a year I don't sell a house outright and have a smaller income.

The beauty of RE is the control and flexibility how it relates to all the moving parts of your overall financial picture. Sell this year or next, 1031, etc.

@Dylan Mathias

Yes we do have clients with checkbook IRAs that we administer. 

Buy and hold or flip or both? Master one then the other. Sometimes you fix but then can't sell so you end up in buy and hold. Make sure any flips can carry themselves if you have to hold them. 

@Dylan Mathias

Not sure if this was a typo: "I am moving most of my money into more conservative investments in the economical environment we are in."

Real estate is far from conservative, particularly flipping. Within the real estate world, there are more conservative and more aggressive ways to invest. More conservative would be buying shares of large commercial investments thru various funds, trusts and similar instruments. It's an entirely different conversation and is not about taxes. Investments ideas that were discussed in the earlier comments are more on the aggressive side, with higher potential but also higher risk.

At 24, you probably should not be overly conservative, but I'm alarmed by your mention of it.

A self-directed 401k has a lot of advantages over a self-directed IRA, including higher contributions and not having to worry about taxes on debt-financed investments. If you're going to be self-employed, look into the 401k, including the Roth 401k option.

There're many experts on this BP forum who can offer both advice and top quality service, including @Brian Eastman , @Carl Fischer , @Dmitriy Fomichenko and others.

Good luck.

@Michael Plaks

Thanks for the "shout out" I believe risk is more associated with knowledge, control,  and experience. Not as much on the asset class. However, at 24 how much experience can one possess?

@Michael Plaks

Thank you for the comment Michael. You misunderstood me. As of now I am slowly moving my funds into more conservative investment like money markets, bonds ect. I was heavily aggressive being almost purely invest in stocks the last couple years and have done very well. I would love to get your thoughts on this but from what I have read and the little experience I have, I think the stock market as well as real estate is extremely overpriced. There has to be a correction in the next couple years and it is just a matter of when. My strategy was to be aggressive and now I am leaning towards safer investments (Money Markets, CD's and Bonds) for now until I have a better idea of what the future of the economy looks like. 

I am only looking to invest my retirement accounts in real estate if we get a big correction. I live in an area (Northern California) where houses are more elastic per say. During downturns they get hit harder because people over extend themselves to buy here but then they rebound faster then most parts of the country and have great appreciation. 

I might be naive but I am willing to take the risk of loosing a little on the upside because where we stand, there is a greater chance to the downside. 

Love to get your thoughts on this. 

With that being said I will for sure look into the 401k option as well. 

@Steve Vaughan

Thank you for your response. I totally see where you are coming from and think it is actually smart. I was planning on doing exactly what you are saying to do. I took advantage of my employer match and this year I will be in a lower tax bracket because I am leaving my job and starting a company with my brother. On paper it is looking as if we will make very little with all the write offs from starting the company. I was going to take advantage this year when I will be in a low tax bracket to roll over to my Roth. I personally think I will be making more than I am in retirement and I do not think taxes will be this low in 50 years so I really like the idea of getting my money into a Roth and letting it grow tax free. 

@Dylan Mathias

1. IRA Services Trust Company out of San Mateo offers self-directed Roth IRAs.

2. You could open a Roth IRA with them and transfer your pretax 401k directly into the Roth IRA without having to first transfer to a traditional IRA.

3. The self-directed Roth IRA can then be invested in real estate, with all the income and expenses flowing through the Roth IRA.

4. The gains would then grow tax free and you could commence tax free Roth IRA distributions once your turn age 59 1/2 and have had the Roth IRA for at least 5 years.

Good Resources

https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-iras-investments

https://www.irs.gov/retirement-plans/plan-sponsor/types-of-retirement-plans

https://www.irs.gov/retirement-plans/roth-iras

https://www.irs.gov/retirement-plans/rollover-to-a-roth-ira-or-a-designated-roth-account

Originally posted by @Dylan Mathias :

Hi all, 

While in college I worked fulled time at a fortune 500 company. I was able to put away a good amount in my 401k in the two years I have been at the company. I am now leaving the company and am going to roll my 401k into a tradition pre-tax IRA and then a self direct post tax Roth IRA.

I am moving most of my money into more conservative investments in the economical environment we are in. 

I am wondering if anyone has information on how to invest in real estate rental properties with a Roth IRA. I have heard you have to hold your money with a 3rd party and besides that you can pretty much just use the money to invest.

I wanted to get peoples thoughts and if anyone knows someone that specializes in this area. I live a little North of San Francisco so someone close to that area would be great.

Very carefully. :) But seriously, there are so many traps to SDIRAs in RE; every SDIRA file I've reviewed the client / potential client has done something that would likely invalidate the tax treatment of the entire account on audit. Purchasing single $0.99 candy bar with the wrong debit card can invalidate the entire SDIRA. The rules are very picky, there's a LOT of bad information on the internet about what you can and can't do. In my practice I tend to advise against them as I'm conservative in nature when dealing with tax risk. So, I say use your IRA funds to buy REITs if you want RE exposure without risking the tax treatment of your IRA.

My experience is that most clients aren't willing to or capable of following the very specific rules required for a SDIRA + real estate. OR, the client thinks they'll simply never get audited and are willing to roll the dice. (Which is not an attitude I encourage.) I'm sure many on this forum have a different opinion than me. 

@Dylan Mathias I have talked to Scott Maurer from advanta IRA several times for my clients to use him on stuff. He can help you if you want to reach out to him. But essentially what you need is a 3rd party custodian. They don't need to be where your from to do this if you are comfortable with that..