Using self-directed IRA funds to invest in rentals -- anyone?

Pat L.

Rental Property Investor · Upstate, NY · Member since 2012 · 3k+ posts · 3k+ votes

For MANY years we've always had a checkbook 401(k)-solo so very different to the SDIRA concept but the end result is exponential. We prefer to pick up tax lien auctions & foreclosures then flip them to fellow investors holding a CFD or note with a HRR.

Michael Glaspie

Real Estate Consultant · Fayetteville, NC · Member since 2017 · 151 posts · 144 votes

I would suggest you look into a Qualified Retirement Plan (QRP) as well. Look at the pros and cons of each. I am in the middle of transferring over my army retirement plan to another vehicle. So a lot of information is being discovered.

Kenneth GarrettPro Member

Investor · Florida Panhandle/Illinois · Member since 2016 · 4k+ posts · 3k+ votes

@Blair Treu

You can buy rentals with your SDRF. You can get a mortgage (non-recourse). You will end up paying some UBIT tax on the borrowed portion. Can’t work on the property, can’t live on the property, you can manage it.

Check out Mat Sorensen book The Self Directed IRA Handbook. He and Mark Kohler have a Podcast every week. Many SDRF questions are answered there especially during there open forum shows.

Good Luck.

5 Reply

Daniel DietzPro Member

Rental Property Investor · Reedsburg, WI · Member since 2011 · 1k+ posts · 857 votes

[email protected]608-524-4899

We own about 1/3 of our 30 units with retirement funds of some kind, meaning SDIRAs or SOLO401Ks and it has been very good for us.

The main reason that we started down this road is because that is where a very large portion of our assets (>75%) were already. Once we tapped out our cash on hand for down payments for conventional rentals it was the logical next place to turn.

The UDFI (?) tax *can* be there with a SDIRA but it is typically VERY minor. The condensed version, to my understanding, is that if you leverage say 50% in a SDIRA you *can* write off that interest, *and* 50% of the depreciation too. In the end, it is very similar to traditionally held real estate in that interest and depreciation more or less offset 'profit'. I believe the first $1000 of profit, *after* those deductions is exempt from the UDFI also. One of the Pros in this area, maybe @Brian Eastman ?, has written on this quite a bit.

When we learned about the SOLO401K we switched to that as there is no UDFI on those. We simply did not know about them when we started the SDIRAs, and also part of our IRAs that we rolled were ROTHs, which is about the only kind of retirement plan that can NOT be rolled into a SOLO401K (although you can roll it into a ROTH SDIRA).

We are able to get better than stock market returns with MUCH less risk in our eyes. We already have the self PM in place for the others so it was easy to add another dozen units on.

The downfall is that typically you can only leverage at about 50-60% LTV and rates are about 1% higher.

There is a great book that has 'keep it' in the title about SDIRAs, google it.... worth a read.

We have recently done our first Private Money loan on a SDIRA property too....70% LTV, 5% for 5 years... basically a HELOC to put down on another property.

We are also working on bring in *other* private money partners who would be using *their* SDIRAs to partner with us on our *conventional* investments. We are using Mark Kohler's firm mentioned above to help set that up.

Brian EastmanPro Member

Self Directed IRA & 401k Advisor · Wenatchee, WA · Member since 2014 · 2k+ posts · 2k+ votes

@Blair Treu

Investing in rental property with a self-directed IRA can have a lot of positives. Yes, it is different from investing in properties personally in that the income is not taxed, so there is no need for offsets with deductions against income, and things must be done very much at arms' length. It is also very different from having your IRA wholly invested in conventional assets such as the stock market where you are playing a much more speculative game and subject to the volatility of the news cycle. Real estate is a stable asset that produces consistent returns, but at rates vastly superior to other stable assets such as CD's and bonds. You already know this based on your experience with your personally owned properties.

An IRA may leverage. Debt must be non-recourse meaning no personal guarantee. In this instance, the IRA is subject to a small amount of taxation on the percentage of income derived from the non-IRA (borrowed) money. Now that taxation is occurring inside the IRA, the IRA can take advantage of offsets such as depreciation and other deductions.

You can administer investments, so a certain level of management is allowed. You may not benefit from or provide benefit to the IRA, so sweat equity is a no-no.

There are several self-directed plan formats, so get on the phone with a few providers here on BP and see which will best suit your needs. Generally speaking a Checkbook IRA or Solo 401(k) will be much more nimble, time efficient, and cost effective than the processing services of an IRA custodian when it comes to managing one or more rental properties.

Most anyone can establish an IRA. For those who are self-employed and have no full time employees, the Solo 401(k) can provide some additional benefits. BTW, there is one newer group thinking they are cute/unique/special by calling the Solo 401(k) a QRP (Qualified Retirement Plan). It is the same thing. (For @Michael Glaspie)

4 Reply

Bill B.

Investor · Las Vegas, NV · Member since 2013 · 8k+ posts · 10k+ votes

Don’t forget. You’re also turning 15% tax capital gains income in to 30% tax regular income. And don’t do any personal work on the property or ever stay there. Or your relatives.

If you have absolutely no other access to money it’s probably better than doing nothing as long as you don’t make one mistake and make the whole account non-qualified.

Taylor L.

Rental Property Investor · RVA · Member since 2016 · 5k+ posts · 4k+ votes

I use my SDIRA for multifamily and self storage syndications. It's much better suited to syndications because there's no risk of mixing funds, it's far easier to get leverage, and I can invest entirely passively.

1 Reply

Brian EastmanPro Member

Self Directed IRA & 401k Advisor · Wenatchee, WA · Member since 2014 · 2k+ posts · 2k+ votes

@Bill B. While technically accurate, your analysis comparing real estate income inside of an IRA to investing personally is an apples to oranges comparison.

When an IRA creates gains in the stock market, you are turning capital gains to earned income when you ultimately distribute from the IRA. Real estate is the same.

The more apt comparison is; "Will real estate in my IRA perform better for my IRA than stocks"?

Using a self-directed IRA is not about you investing in real estate and having access to the IRA money. Rather, it is about diversifying the IRA. In that light, real estate can make a whole lot more sense as a stable asset not subject to the whims of the media cycle that produces consistent income.

Tom Makinen

Member since 2019 · 226 posts · 115 votes

Go look up irs crack down on self directed ira properties from a few years ago. They made it clear they will look at them closely. You make one mistake and your entire house will be subject to income tax plus penalties.

Dmitriy Fomichenko

Solo 401k Expert · Anaheim Hills, CA · Member since 2012 · 18k+ posts · 6k+ votes

https://www.biggerpockets.com/blogs/2810/50272-list-of-non-recourse-lenders-for-self-directged-ira-and-401k

Originally posted by @Blair Treu:

I'm aware that there are restrictions such as; the properties must be paid for in full and owned free and clear (no loans) and that my IRA is the "owner" of the property not me personally but I own the IRA.

You can use leverage when buying property inside of an IRA, however because as "disqualified person" you are not allowed to provide a personal guarantee the loan must be non-recourse. Most banks don't do this types of loans, however there is a handful list of lenders specializing in this, you can find this list here:

In an IRA it will trigger UBIT tax, however Solo 401k is exempt from this tax on leveraged real estate.

Brian EastmanPro Member

Self Directed IRA & 401k Advisor · Wenatchee, WA · Member since 2014 · 2k+ posts · 2k+ votes

@Tom Makinen

Please be careful with such broad assertions. You are promoting cynical falsehoods promulgated by those with a financial stake in keeping people from taking control of their own money. It is easy to write articles on the internet designed to scare folks into leaving their money with Wall Street (where there are absolutely no crooks, BTW). There is, however, no basis in fact or reality for the assertion that the IRS is cracking down on IRA investors diversifying into alternative assets such as real estate.

We have been in this business for 14 years. We have setup several thousands of plans. We have even had a very small handful (> .05%) of clients get audited. 100% of those folks came out A-OK because they were operating within the rules. it is very easy to do so as long as you understand that there are rules.

Yes, when someone decides to use their IRA to benefit themselves directly and gets fried by the IRS, you hear about it. It takes a clear disregard of self-education to engage in the types of transactions we have seen in the tax courts in the last 10+ years. On my 2nd day on the job I would have known not to do what these folks have done such as lending to themselves or acquiring property in an IRA to then sell to a development company they own personally. If you put even a modest effort into understanding the IRS rules and surround yourself with a team of advisors to guide you (CPA, etc.), it is very easy to operate within the rules.

The budget of the IRS gets cut more and more each year. They are operating on computer systems built in the 1980's or earlier and have reduced audit staff by something like 40% in the last several years. Yes, you want to assume that you will get audited and operate accordingly. We certainly encourage our clients to take that approach. But the reality is you are more likely to win the lottery and get bitten by a shark on the same day than to have your IRA audited.

So, if you think that you can produce better results for your IRA by investing in real property, learn how to do it right and you can sleep very well at night.

1 Reply

OP

Rental Property Investor · Orem, UT · Member since 2016 · 7 posts · 3 votes

Very helpful Brian. Another question if I may? I've have not had any experience with non-recourse loans. Are they typically given at a higher rate than a typical investor loan on a non-occupied property? And how is the tax in a leveraged situation calculated? Anyway, thanks for the advice. I will look further into this.

OP

Rental Property Investor · Orem, UT · Member since 2016 · 7 posts · 3 votes

Kenneth, thanks so much. What is "UBIT" tax? What does the acronym "UBIT" stand for and how is it calculated?

OP

Rental Property Investor · Orem, UT · Member since 2016 · 7 posts · 3 votes

Thanks so much for the resource list Dmitry! I will look into this list and learn what I can. Most appreciated!

OP

Rental Property Investor · Orem, UT · Member since 2016 · 7 posts · 3 votes

Daniel, Thanks so much. I noticed your phone number at the bottom. I may give you a call if that's ok. Interesting to hear your perspective. Thanks so much!

Brian EastmanPro Member

Self Directed IRA & 401k Advisor · Wenatchee, WA · Member since 2014 · 2k+ posts · 2k+ votes

@Blair Treu

Non-recourse loans will typically be more conservative and expensive than loans for which you provide a personal guarantee. There are a handful of lenders that specialize in such loans for 1-4 unit IRA investment properties. North American Savings Bank (MO) First Western Federal Savings (SD) and Titan Bank (TX) are main players.

Expect:

30-40% down payments

10-15% reserve requirements

1.10 Debt service coverage

5.5-7.5% interest depending on the loan type/term

When an IRA uses debt financing, it is receiving the benefit of using non-IRA funds (the borrowed money) inside the IRA envelope. This creates Unrelated Debt-Fiananced Income (UDFI). The resulting tax paid is Unrelated Business Income Tax (UBIT).

Example:

$100K property purchase

$40K IRA down payment / $60K non-recourse loan

Property is 60% debt financed

60% of gross income is taxable

60% of common offsets such as depreciation, interest on the note and other allowable expenses are deductible.

There is also a $1,000 standard exemption

Net taxable number is then run through the trust tax table to determine the tax owed by the IRA (which is a trust).

In this case, assuming about 10% return, expect $175-200 in UBIT per year. This is a small fraction of the boost in cash-on-cash return the IRA will receive as a benefit of using leverage.

All of this is a standalone return (form 990-T) for the IRA and does not intersect with your personal return in any way.

See IRS publication 598.

* * *

Of course all of this is very different from investing in real estate with non-qualified funds. Don't get in the trap of comparing the two. What you want to compare is the risk/reward performance of a leveraged real estate investment in your IRA with that of a non-leveraged real estate investment, or some other investment such as the stock market also in the IRA. How can your IRA get the best results? Leverage can be a powerful tool to achieve great returns for your IRA if done properly.

3 Reply

Jared Friedman

Investor · Studio City, CA · Member since 2016 · 38 posts · 54 votes

@Blair Treu

I own several turnkey rentals in my sdira for the Cashflow. Find a good true turkey provider. They do all the rehab and property management. Most of them deal with many folks who use Ira funds. It’s completely passive and the closest you’ll get to little to no compliance issues on your end in buying real estate.

Dave FosterBusiness Member

Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes

@Brian Eastman and @Dmitriy Fomichenko, A follow up question for you both. How does an investor in real estate using retirement funds deal with the distribution of that property when the time comes. Assuming it's required minimum distribution time, and the property is dialed in and something I would want to keep rather than liquidate and replace with cash in my retirement account? Any solutions to that dilemma?

The 1031 Investor5137 Reviews

Website View Page

Brian EastmanPro Member

Self Directed IRA & 401k Advisor · Wenatchee, WA · Member since 2014 · 2k+ posts · 2k+ votes

@Dave Foster

If the property is producing cash flow, then you have the option of keeping the asset in the plan and distributing the income. A property producing 5% return will be able to meet your RMD needs without needing to sell until about age 86.

You can distribute an asset in-kind, but that is not always the most beneficial strategy. The property needs to be appraised. The property is then re-titled from the IRA to you. The value of the property is considered a taxable distribution. Distributing a large value all at once will generally put you in a high tax bracket. Some may promote taking fractional distributions over time, but that can get really complicated and expensive, as well as introducing some compliance risk. We typically do not see a cost-benefit to such an approach.

Another popular strategy is to sell a property to an unrelated party, and have the IRA carry a note. You get a boost of liquidity, get to retain a stable asset producing consistent cash flow to meet your RMD needs, and can liberate yourself of dealing with tenants as you age.

3 Reply

Dave FosterBusiness Member

Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes

Very helpful as always @Brian Eastman, Stay warm out there. We just left Winter Park with 2 inches of new snow!!!

The 1031 Investor5137 Reviews

Website View Page

Tom Makinen

Member since 2019 · 226 posts · 115 votes

@Brian Eastman I saw half of our clients on self directed ira with property got audited. Some made it through, some didn’t and they ended up with a nasty bill. You can certainly do it, but you better not f it up.

I still remember this guy in Vegas that had a 4plex. He did several small repairs and improvements himself. irs ended up disallowing it and he lost his ira and they made him pay 6 figures on it

Justin WindhamPro Member

Banker · Nationwide · Member since 2015 · 4k+ posts · 1k+ votes

@Tom Makinen

The key is to understand and follow the prohibited transaction rules. Yes, a PT in an IRA results in a distribution of the IRA. If the IRA is large enough, the resulting tax bill can be huge. While the penalty is not so severe with a Solo 401k, I agree, one should be educated on the rules to stay out of trouble.