Self Directed IRA's, Thoughts And/Or Advice?

Question

Any thoughts and/or advice on self directed IRA's?

Brian Eastman · Answer

@Ben Smith

What you have asked is a tremendously broad and open ended question.

The simple answer is that a self-directed IRA (in various forms) is a means of diversification that allows the IRA to invest more broadly than just the stock market.  As a tax-sheltered retirement plan, everything must be done at arm's length and exclusively for the benefit of the retirement plan.

So, if you happen to have expertise in some asset class such as real estate or private lending where you believe you can have a better mix of risk/reward and more successfully grow your retirement nest egg, then a more thorough analysis of the topic would be worth your while.

George Blower · Answer

@Ben Smith

1. Yes the existing Roth IRA can be transferred to a self-directed Roth IRA custodian such as IRA Services Trust Company. This custodian will service IRAs that can be invested in alternative investments like notes, real estate, and tax liens, to name a few investment types.

2. You can contact the self-directed IRA custodian directly to setup the self-directed IRA and they will request for the non-taxable transfer of the IRA to the self-directed IRA.

3. Regarding processing Roth IRA distributions, the tax treatment of Roth IRA distributions depends on whether the distribution is considered qualified or nonqualified.

If a Roth IRA distribution is qualified, all distributed assets are tax-free. If a distribution isnonqualified, some of the assets (generally the earnings) may be subject to regular income tax and a 10 percent early distribution penalty tax unless the Roth IRA owner qualifies for a penalty tax exception.

Tax laws require Roth IRA assets to be distributed in the following order: regular contributions, conversions and retirement plan rollovers, and earnings (IRC Sec. 408A(d)(4) and Treas. Reg. 1.408A-6).

Brian Eastman · Answer

@Jason Bilbrey

An IRA may use leverage.  Per IRS rules, any debt instrument must be non-recourse.  The IRA is the borrower and the property is qualifying for the loan - not you.  As a disqualified party, you may not pledge a personal guarantee for the IRA's debt.

@Roger StPierre is one of a handful of lenders with expertise in this space.  Go ahead and chat with him and learn what is possible for an IRA to borrow in terms of property types, condition, rates, etc.

The use of debt-financing in an IRA produces Unrelated Debt-Financed Income (UDFI) to the IRA.  The portion of the income that the IRA receives that is attributable to the non-IRA (borrowed) money is viewed as taxable.  The IRA then gets to apply the same ratio of normal deductions such as depreciation, interest payments on the note, etc. to reduce the taxable amount.  For most investors, the cost of UDFI taxation and tax preparation is not significant, and the IRA should definitely receive a benefit of higher cash-on-cash return via the use of leverage.

If you are eligible by fact of being both self-employed and having no full time employees, then you may be eligible for a Solo 401(k) plan.  As with the IRA, any debt instrument must be non-recourse.  However, the Solo 401(k) is exempted from UDFI derived from investments in real property.  That can simplify your life and put a few extra bucks back into the plan each year that would have gone to taxation.

Asset protection is really dependent on your situation in terms of markets, property values, risk tolerance, etc.  Generally speaking, quality insurance will be the most cost-effective route.  You can create more robust asset segregation schemes within the IRA LLC or Solo 401(k) umbrella.  Our attorney is not yet sold on the concept of the series LLC.  There is just not the case law yet to prove the cell segregation concept will actually hold in practice.  The cost and complexity of administration as compared to just having separate standalone LLC's is generally not much different.  It would be very easy to neglect the necessary administration and therefore lose the purported benefits of segregation.

Dmitriy Fomichenko · Answer

@Jason Bilbrey, creating an LLC for each rental would be an overkill in my opinion. Just make sure you have adequate amount of liability insurance for each rental, on top of that you can purchase an umbrella insurance policy which comes in increments of $1MM.

When you use leverage to acquire investment property in an IRA - portion of the IRA income will be subject to Unrelated Business Income Tax (or UBIT), your IRA will owe and have to pay this tax. If you are eligible for a truly self-directed Solo 401k plan - that might be a better options since 401k would be exempt from UBIT on leveraged real estate.

Roger StPierre · Answer

Jason,

I can speak to the non recourse piece. IRS rules require that any leverage or loan that a self directed IRA or 401(k) Trust MUST BE non recourse. There is no other permitted type of loan possible. What this means is if there is a default by the SDIRA on the loan, the lender has No Recourse to collect any deficiency that may be left once the lender forecloses and sells the property. You do not sign for the money personally and have no personal obligation either.

As far as whether you want to create a single LLC or series, that is entirely up to you.

Ben Smith · Answer

Daniel Dietz,

Who is your SDIRA custodian?

Ben

Daniel Dietz · Answer

You are getting some good advice here.

I have both SDIRA that is in a ROTH account which rolled over from a regualr ROTH IRA, and a SOLO401K Tradtional account that was funded by roll overs and additional contributions.

The one thing I was surpried at is that there is NO way to roll a regualr ROTH IRA over to a ROTH SOLO401K. It seems to be one of the few/only conversions you CANT make.

Dan Dietz

Dmitriy Fomichenko · Answer

@Ben Smith

Yes, any IRA can be converted into self-directed (Traditional, Roth, SEP...). To do so, you will need to find a custodian allowing alternative investments, open new account with them and fund it with the rollover from your existing IRA.

The income from the property owned by the IRA belongs to the IRA. The distributions, tax and contribution rules for self-directed IRA are the same as for conventional IRA. There is an annual limit on contributions, distributions from Traditional IRA are taxed at withdrawal plus penalties if you do so prior to age 59 1/2. For Roth you can take out your contributions at any time (contributions come out first), for earnings you would have to wait until 59 1/2.

Ben Smith · Answer

Thank each of you for your replies. This is a deep topic with a lot of variables. Let me narrow my question, and add a few follow on's:

1. Can my existing Roth IRA be converted to a self directed IRA?

2. If so what is the process?

3. Can the income generated by a cash flowing property inside the SDIRA be taken out without severe penalty?

Jason Bilbrey · Answer

@Roger StPierre or anyone else... I've been devouring every article I can find on SDIRAs the last couple of weeks but still am a little confused on leverage. Normally when making a real estate purchase I'm leveraged and its a recourse loan (which basically means the bank can come after my assets).

If I open an SDIRA and then create a IRA LLC to get checkbook control, are there rules about loans than it must be non-recourse because it's inside an IRA? Or do some lenders provide recourse loans that if the investment went belly up they could seize all the IRA assets and then come after personal assets outside of the IRA?

Also another broader question, but related. Some people have suggested that investors get a series LLC and then put each investment property under its own series. Others suggest a new LLC for each property. Either approach's goal appears to be to prevent one investment from hurting your other investments or personal finances. When using an SDIRA to purchase real estate, should I

1) Create a separate IRA LLC per investment property all under the same IRA account?

2) Create a separate IRA LLC and separate IRA account per investment property?

3) Is there such thing as an IRA Series LLC? Should I create one of those under a single IRA account?

4) Create a single IRA LLC under a single account for all properties?

Self Directed IRA's, Thoughts And/Or Advice?

Most Popular Reply