using IRA to buy real estate

23 Replies

Hello BP members!

I've listened, read and debated a lot of material about using retirements funds in a self-directed IRA to invest in real estate. The rules seem really cumbersome and complicated, and since I'm still fairly young (29 today), I'm considering just cashing out my retirement to just use to invest normally (likely in a multifamily deal) so I can take the cashflow as income (can't do this in self-directed IRA). I know that I'll be hit w/ the 10% early distribution penalty and it'll be taxed as income in that year.

Am I missing something? Is there something better or easier? Thanks in advance for all answers, help and opinions!!

@Brandon Komp

The point of a retirement plan is to provide tax sheltering.  When the income the plan receives is not taxed, but rather available to be reinvested, you gain the benefits of compounding that tax savings over time, and will be able to mushroom the savings value considerably as a result.

In exchange for that tax-sheltered status of the IRA, there are rules to keep everything isolated within the IRA. You cannot personally benefit today, whether your IRA is invested in real estate or the stock market. This is money for your future self, and if you play it well, you can create a lot of future income.

Please speak with a licensed financial advisor or tax professional before destroying your retirement plan with an early distribution.

@Brandon Komp

How much $$$ are you talking about? Interesting that most people your age barely no what an Ira is and you are considering dumping it. I am curious  as to why you started it in the first place -if you care to elaborate.  However, If you really need the money, take it and make income with it to use now so you can eat. 

However, you are giving up a capability now to earn tax deferred or tax free money. I would try to make money in my ira and outside the Ira. As you age that tax free money is great. Our clients tell us “I wish I had known about this earlier.”

You can start an Ira again once you are in a better position.  When and if you end up paying a lot of tax you will want some tax free income. Some people work twice as hard and keep half the money because they don’t want to learn the rules or be bothered by the cumbersome and complicated rules. These rules are what societies/governments  use to make the rich richer and the poor poorer.  

Do what you need to do. I wish you the best of luck! 

@Brandon Komp

Of course, if you take a distribution from your retirement account you will have to pay the taxes and (likely) penalties.

There are possible alternatives which would allow to you use these funds without paying taxes or penalties.

  • First, you may wish to consider transferring the funds to a self-directed 401k or IRA which will allow you to invest in real estate without incurring taxes or penalties. Please see additional considerations below.
  • If you are eligible to set up a self-employed Solo 401k (or have a 401k plan through an employer which accepts rollover contributions and allows for 401k participant loans), another alternative which would avoid taxes and penalties would be to transfer your funds to such a 401k plan and then take a 401k participant loan. Please see additional considerations below.

401k Participant Loans

  • If your 401k plan allows for 401k participant loans, the maximum loan amount is equal to 50% of the balance up to $50k. The repayment terms for a 401k participant loan are equal monthly/quarterly payments of principal and interest (typically prime plus 1%) over a 5-year term (longer if used to acquire your principal residence).
  • Please note that if you take a full $50,000 and then pay back the loan, you can't take another $50,000 until 12 months after the first loan was fully paid back.
  • Per the loan offset rules that went into effect with the 2018 Tax and Job Act: if you leave your job and the loan is current at the time you leave your job but then the loan goes into default because you left your job, you will have until your tax return deadline (including any timely filed extension) to make the loan current by depositing the outstanding balance into an IRA (and thereby avoid the taxes and penalties that would otherwise apply).

Solo 401k vs. Self-directed IRA

If you are self-employed with no full-time w-2 employees, you can set up a Solo 401k & rollover funds from a non-Roth IRA as a tax-free direct rollover and then invest in real estate.

A Solo 401k has several advantages as compared to a Self-Directed IRA including the following which specifically apply to your situation:

  • Unlike a Self-directed IRA, you can have the account for the Solo 401k at a bank or brokerage that does not charge maintenance fees and where you will have checkbook control.
  • Unlike a Self-directed IRA, if you use leverage (which must be non-recourse financing in either case) to acquire real estate with your Solo 401k the income will not be subject to Unrelated Debt Finance Income tax

General Considerations Re Investing Retirement Funds in Real Estate:

1. If you purchase via an IRA (as opposed to a 401k), you will need to open an IRA account at a specialty trust company which allows for investments in real estate. Unless you invest via an LLC owned by the IRA, you will not have checkbook control over the funds which means you need to run transactions (e.g. income, expenses, etc.) through the trust company who will need time to process the transactions and generally charge fees for each transaction. On the other hand, keep in mind that there are costs associated with maintaining an LLC (such as the $800 annual franchise tax in California).

2. If you are self-employed with no full-time employees, you can set up a Solo 401k through a 401k provider which allows for investing in real estate. In that case, you can simply have the account at a bank or brokerage where you will have direct checkbook control.

3. In either case, all of the income and expenses will need to flow in and out of the retirement account.

4. In either case and if you will you debt to acquire the real estate, it must be non-recourse financing. See more at the following link: https://www.biggerpockets.com/blogs/9552/70408-ira... If debt-financed real estate is acquired via an IRA, any income attributable to such investment will generally be subject to unrelated debt finance income tax.

5. In either case, you can't live on the property or otherwise use it for personal use.

6. In either case, you can't work on the property as it must be a passive investment (e.g. you must hire someone to fix the toilet and can't pay the expense with non-retirement funds).

7. In either case, you must purchase/sell real estate from/to an unrelated person and the real estate can't be titled in your name personally (e.g. in the case of the 401k, it would be titled in the name of the 401k and you would sign as trustee of the 401k).

8. In either case, you should verify that you are eligible to transfer the funds from your existing retirement account (e.g. if the funds are in your current employer 401k, you will likely not be able to transfer until you quit your job). 

Originally posted by @Brandon Komp :

Hello BP members!

I've listened, read and debated a lot of material about using retirements funds in a self-directed IRA to invest in real estate. The rules seem really cumbersome and complicated, and since I'm still fairly young (29 today), I'm considering just cashing out my retirement to just use to invest normally (likely in a multifamily deal) so I can take the cashflow as income (can't do this in self-directed IRA). I know that I'll be hit w/ the 10% early distribution penalty and it'll be taxed as income in that year.

Am I missing something? Is there something better or easier? Thanks in advance for all answers, help and opinions!!

 Your Question: "Am I missing something? Is there something better or easier?" 

Yes, actually there is.

First let me state that for most people, what the guys above say about 401(k) & IRA investing is correct. For the average person, who does the average type of investing and wants average returns, it is a safe approach to investing. As we perceive the economy, interest rates, inflation, taxes and laws in today's terms, if we believe that none of those will change in the next 30 or 40 years, the numbers work.

Since I buy "Subject To" and sell on Lease Option to Tenant Buyer's & get $20,000 to $25,000 down from them and cash flow $500 to $800 a month per property, the numbers Don't work for 401(k)'s and IRA's. What I do can be done inside 401(k)'s and IRA's of course, but it slows down wealth building.

For one, the income and cash flow from how I invest, quickly exceeds the limits allowed for 401(k)'s and IRA's. I can't "protect" enough of my "in coming" cash and asset growth.

Secondly, by trying to stay within compliance, I would have missed some of the opportunities that have made me considerable amounts of money.

Thirdly, I personally believe that the economy, interest rates, inflation, taxes and laws will change for two reasons (a.) It always does change and (b.) the amount of debt we carry as a nation will need to be paid and the likely place to get the money is the huge amount of money in 401(k)s and IRA's that is "locked in". One simple future change of the law and what is "taxed deferred" today can become "highly taxed" tomorrow.

Fourth, flexibility. What if real estate is no longer the best gig in town? What if you want to diversify to something not allowed by the 401(k) & IRA rules? What if you want to help a family member financially - what are the restrictions? what if you want to jointly invest with a direct lineage family member? Life happens and life doesn't always follow the rules set up for 401(k)s & IRA's such as medical, job loss, other "life events".

I invest a lot, make a ton of money, pay my taxes and have total freedom what I do with my money. Because of the WAY I invest, I get all of the benefits, tons of tax write offs, and therefore have limited tax liability. I have more "cash flowing" assets as a result. (think Warren Buffet on a much smaller scale but still a good example.)

Yes, you can be average and benefit from a 401(k) or an IRA, or you can take it to the next level and understand how the system works and profit from that knowledge. And I'm pretty sure that is what you are seeking an answer to.

It's easier to show on a spreadsheet so I put this together a while back: Notice the nuances as you go down the rows. Simple to implement and elegant by design. 

Average Turnkey Cash Flow Per Door In Phoenix Metro Area

https://www.biggerpockets.com/forums/600/topics/584916-average-cash-flow-per-door-in-phoenix-metro-area

@Carl Fischer

It is not a large sum, I only have about $80k right now, but that could go a long way right now toward investing in more real estate to generate income today. It is in a company sponsored 401k, and I've contributed to it from day 1 since I was 22 to get the max company match. It was started whether I wanted it or not, and it was good to have it and I recognized that, but now it is very hard to resolve not having access to money I've invested and that has grown simply because I'm not of a certain age. I've already taken a loan against it to get started in real estate and that has gone well thus far, outpacing the market over the same time. 

Besides even being cumbersome w/ all the rules and regulations and causing missed opportunities, I think the tax deferment I'd be giving up is also diminished by the fact that real estate held in a self-directed IRA does not get the benefit of depreciation nor can you do a 1031 exchange. Both depreciation and the 1031 exchange with today's money, in my opinion, kind of level the playing field of tax deferment for future money.

The tax deferment benefit in my case I do not think is great enough to win out. Since I am still "young" I still hopefully have a lot of time left. I agree with your comment to make money in and outside of an IRA. A traditional IRA or 401k plan though are not the best for me because of this time remaining. The direction I'm going and the life plan I have, I should be in a much higher tax bracket than where I'm at now. So a Roth would make the most sense (and I have one started already for the day I have residual income to start socking away again). If I can grow money tax-free for the next 30yr and only pay tax on $80k now instead of on some millions (hopefully) later, that should be a far greater benefit to me. It also provides the flexibility to access the funds invested should the need or want ever arise to do so instead of it all being locked away.

This is my perspective based on my situation. I consider myself not the typical millennial, but try not to give up on our generation yet! Thank you for your time and input to my question!

Originally posted by @Sejj Jackson :

@Brandon Komp Instead of cashing out, you can take a loan at 1% interest to yourself using your IRA money. But if your not experienced in real estate I wouldn't recommend this.

There is no such thing as loan to self from IRA. This is incorrect info!

I'd also like to jump in here instead of starting a new thread, thanks in advance.  I have a question about UBIT...

I'm not self employed so I don't think I qualify for a SD 401K.

I want to invest my retirement funds in a passive real estate syndication deal inside an IRA. All I would do is cut an initial check to the syndicator and then receive quarterly disbursements and a lump sum after the deal is sold.

I 'think' my only option is either a SD Roth or Traditional IRA.

Anyone know the probability of getting hit with UBIT?  

Thanks in advance. 

Buddy, I just did this to finance my second property and man did I pay for it. On top of the 10% penalty for early withdrawl, I also had to pay another 24% for state and federal taxes. This all being said, I would do it again because I needed to jump on this deal and will make back all my money in 1.5 years. There are many other ways to get significantly cheaper loans out there, but I did what I thought needed to be done at the time.

@Christopher G.

You're correct. Without a business or self-employment activity, the Solo 401k is not an option, but a self-directed IRA would work. For the passive investment you described, UBIT would generally not apply based on equity in an active trade or business, though you should ask the syndicator about whether the investment is likely to generate UDFI for an IRA.

@Sejj Jackson

You have incorrect knowledge, here is what IRS says about loans from an IRA:

"Loans are not permitted from IRAs or from IRA-based plans such as SEPs, SARSEPs and SIMPLE IRA plans. Loans are only possible from qualified plans that satisfy the requirements of 401(a), from annuity plans that satisfy the requirements of 403(a) or 403(b), and from governmental plans. (IRC Section 72(p)(4); Reg. Section 1.72(p)-1, Q&A-2)"

And here is a link to the IRS website for reference:

https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-loans#1

@Christopher G.

The real estate syndication deal is probably will be leveraged, as a partner in the deal you will receive a K1 with your share, which will include your share of leverage as well.  This in turn will probably trigger UBIT. Talk to a CPA with expertise on this topic. 

@Sejj Jackson

You don't know what you are talking about! Here is what IRS says about taking a loan from an IRA or using it as collateral for the loan:

"If the owner of an IRA borrows from the IRA, the IRA is no longer an IRA, and the value of the entire IRA is included in the owner’s income. (IRC Sections 408(e)(2) and (3))

If the owner of an IRA pledges part of the IRA as collateral, the part of the IRA that is pledged is treated as distributed. (IRC Section 408(e)(4))"

Here is IRS reference:

https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-loans#2

@Christopher G.

You may have heard that Solo 401k's (unlike IRAs) are exempt from UBIT which is an oversimplification of the facts. UBIT is assessed on a 401k or IRA with income from equity ownership of an active trade or business. There is no way around that, though the account may be able to take deductions against the taxable income. UDFI is type of UBIT and the 401k is generally exempt from UDFI on real estate. Some syndications do not generate UDFI for IRAs and 401ks, while others do, so it's still good to learn what you can about the investment and work with a qualified tax advisor.

@Dmitriy Fomichenko If Fred Flintstone has an IRA and Fred is setting up an LLC for real estate investing inside the IRA, can Fred Flintstone be the manager for the LLC or is that prohibited?