This is the big disadvantage of this type of account, IMHO.
A checkbook IRA LLC gives you the control you want, though with more risk. I had a loan to a rehabber go bad a couple of years ago, took back the house, fixed it and sold it. I can't imagine how difficult this would have been without the Checkbook IRA.
Even if you have your IRA get a credit card from Home Depot, will Equity Trust write them a check for a payment? I'm doubtful. Its just to easy for you to have spent the money on something else. OTOH, if the IRA doesn't pay, the money you spend is a contribution, and that has tax consequences.
Your IRA has zero chance of getting a Home Depot credit card, though. HD will want your social security number, which you CANNOT give. You cannot give any sort of personal guarantee for anything your IRA does.
Have your contractor buy supplies and include them in his billings.
Is this a fix and flip? If so, are you familiar with UBIT?
This is the big disadvantage of this type of account, IMHO.
A checkbook IRA LLC gives you the control you want, though with more risk. I had a loan to a rehabber go bad a couple of years ago, took back the house, fixed it and sold it. I can't imagine how difficult this would have been without the Checkbook IRA.
Even if you have your IRA get a credit card from Home Depot, will Equity Trust write them a check for a payment? I'm doubtful. Its just to easy for you to have spent the money on something else. OTOH, if the IRA doesn't pay, the money you spend is a contribution, and that has tax consequences.
Your IRA has zero chance of getting a Home Depot credit card, though. HD will want your social security number, which you CANNOT give. You cannot give any sort of personal guarantee for anything your IRA does.
Have your contractor buy supplies and include them in his billings.
Is this a fix and flip? If so, are you familiar with UBIT?
The only solution to this problem is to find a contractor who is reputable and that wont run off with your money. Never pay too much up front in any case. I had a situation where I wired money to a contractor and he had IRS confiscate my down payment. he was unable to make good and I was stuck with paying twice to get my repairs done. Working with a self directed IRA has many advantages but this is a downside,
UBIT also comes into play when the IRS deems that you are running an active business with your IRA. Flipping homes would get you tagged as an active trader, although I think there is some dispute as to what that threshold actually is. I've had Equity Trust tell me they consider anything under five homes in a year to not be active trading, however I have no idea if that is actually true under IRS guidelines or not.
A way to do this would be to pick out the items and price them out to include tax at HD (Typically at the contractors desk). Then your SD IRA admin could then write a check to HD for that exact amount and you could then take the check and pick up the items. (Best to have a non-disqualified person do it though). So as to make it clear that you are not personally getting a benefit from the items (installing them in your personal residence, etc.)
Probably a better way, would be to have a contractor that you trust, put them on thier account and then have your SD IRA administrator pay the contractor for materials. Just a tricky deal to make sure it is a contractor you can trust.
Just a reminder that dis-qualified people does not include brothers, sisters or brother and sister-in laws ;). It also does not include high school buddies or neighbors that can be paid off with a six-pack and a invite to your BBQ.
The OG poster stated this was a rehab for a rental (buy and hold) not a flip so UBIT will not take effect, IF it were a flip, then yes, it would.
Best two options: As James pointed out, get all the items needed, have the bid desk give you the best price quote, then pay for it all in one check from ETC. Instruct Lowes/HD to only release items you want released to the contractor and store the balance in the back until you release it.
OR
Have your contractor include the cost of materials plus labor and work out a payment schedule of 2-3 payments for the entire job. As he completes each section, a check is released.
1. Have contractor give me estimate of materials (quantities)
2. Go to home depot pro desk and get quote,
3. Have ETC issue a check for the amount of the materials
4. When check made out to HD arrives (mail to myself or direct to HD?), pay and have contractor take materials to property and start work
5. optional -- consider getting a gift card for a few hundred bucks for the inevitable things not planned for--not sure about this aspect
Eric you can not buy materials with personal funds you would have to get an invoice from home depot and get Equity trust to send a check referencing that invoice. I have never tried this but even if Equity Trust sends the check it may leave the transaction open to IRA scrutiny. I may take this up with Equity trust myself as it would solve some of the problems I currently dealing with.
If your ETC office is close, you can pick up the check and deliver it to Home Depot. I would not trust the check getting to the correct person at Home Depot on it's own.
"Buy and hold for cash -> no UBIT (or, more correctly, UDFI)
Fix and flip -> UBIT even if no debt is involved."
Sorry, just a quick segway: @Jon Holdman. how about for a money partner (equity, 50%) with a flipper? Does that belong to the second category above?
And back to ETC, the free bill pay feature lets you pay pretty much everything (as it seems) and everyone. So perhaps it would be OK to pay for someone else's account, like your contractor's CC or HD card.
Ben A To answer your question, intent is key. If the intent of the money partner (equity partner) and the IRA funds is to flip the property, then yes, the IRA profit portion would be subject to UBIT but not the equity partner's share - that would be subject to regular income tax for that partner.
Rather than being money partner, make a loan. The returns on your loan would not be subject to UBIT. At least according to the attorney I've worked with.
Agreed with Jon, the tax implications from flipping may not make sense and buy and hold RE in an IRA is NOT (in my opinion) the best use of those funds. The best use is in buying notes, creating notes, etc. Become the lender in your scenario, keep in mind the usury limits in your state (state you are lending in) and rather than becoming an equity partner, be the other guy's lender. Have him put in 50% of the capital needed, you loan te 50% balance and take a trust deed against the property securing the loan at your set terms and rate.
I actually fund the whole deal he finds, and we split the profit 50/50 (sorry, this wasn't too clear). He gave me a promissory note that states he owes and promises to return the larger of 5% or half of proceeds made by using my fund. In any case we did 3 so far (2 for calendar year of 2011), so from what I've read, I'm under the ">3 flips and your in business" rule(?).
I would be careful based upon the usury laws in your state as they could hit your hard if they consider the 50/50 split proceeds to be interest.
Your best bet may be to invest the IRA money into an LLC as a 50% member that receives the greater of the guranteed interest or the 50% of profit. The main keys are to make sure that your IRA is a limited partner in the transaction.
Buy and hold can be very successful in an IRA under the right circumstances and correct portfolio of properties.
One unanswered question here - how "big" is this deal? If you only need $3k for a rehab, and the deal isn't in the hundreds of thousands of dollars, why not just withdraw the money, pay the taxes, and do what you need to do?
Just because the money is in an IRA doesn't mean you'll *never* pay taxes, only that you're deferring them. If the deal is worth doing, there's enough meat to cover the tax penalties.
Why pay more? If there is a way around it why not do it that way? Depending upon your tax rate, you could lose 40+ percent of the money to taxes and penalties.
Why pay more? If there is a way around it why not do it that way? Depending upon your tax rate, you could lose 40+ percent of the money to taxes and penalties.
-Steven the Tax Guy
Your guide to IRS laws, rules and regulations.
The penalty is 10 percent- keep it in perspective. You are going to pay taxes on the money someday. I'm all for keeping this stuff simple and bulletproof. Do the deal wrong in a self-directed plan, and you'll get additional penalties and interest.
I am keeping it in perspective. The goal of tax free growth is key.
The goal is to supplement wages at retirement, not be an addition to wages.
If an investment is hindered each year by taxes than it will not grow as quickly. If you are in the 25% tax bracket, you will pay 25% plus 10% and if applicable your state rate(~5%). This could be 40%. Not to mention this distribution could be bring most of those dollars into a higher rate. It could move you up to 28, 33 or more. plus penalty and state taxes. So yes in some cases half of the money could be gone just by withdrawing it. That is a bad deal.
You have to factor that typically when many people retire they have a lower overall income. Many the first year or two after retirement will take a large sum to pay off any remaining balance on their home.
Rather than being money partner, make a loan. The returns on your loan would not be subject to UBIT. At least according to the attorney I've worked with.
@Jon Holdman
You sound like you've had success using a checkbook IRA. I'm new to the whole self directed IRA thing and want to set up an IRA owned LLC to have more control. My sister uses Equity Trust and her experience has not been good, so I went looking for a better way. I think the checkbook IRA is a good fit for me. I'm a hands-on kind of person.
I noticed you are in the same neck of the woods as I. Would you mind sharing who your lawyer is here in CO? And who did you use to set up your checkbook IRA?