How to go about doing a self directed IRA

4 Replies

I have heard tidbits about this, but i want to try to get a full understanding. 

With a self directed IRA, i have heard that it is easiest (contractually) to invest money as just a hard lender. If you begin doing any work on the property, it starts creating a bureaucracy nightmare. True?

Second, if the former were true. Does the profit have to be pre-determined? If someone lent me 50k dollars from their self directed IRA, and played the silent investment role and i went about building a new construction. Could you just pay them whatever profit i wanted in the end, and they can deposit it in their IRA, or does it have to be a set percentage already predetermined?

Lastly, can someone use their SEP Ira, or does it have to be Roth...or can it be both?

@Sean H.

Any kind of IRA can be made self-directed. Self-direction is just a different business model for investing that expands options beyond just stocks & funds. Contributions, timelines and all other IRA based rules stay the same. It is difficult to combine IRA funds of different tax types such as SEP and Roth, however.

New construction for immediate sale is a business. If an IRA has an equity stake in such a business and does so on a regular or repeated basis, then an IRA is subject to taxation on Unrelated Business Taxable Income (UBTI), which is designed to level the playing field and protect tax-paying businesses from unfair competition.

As such, for an IRA to participate in such deals, it is best to do so as a lender. In this case, there should be a note with a set rate of interest. Interest income is passive in nature and does not have tax implications under UBTI. You cannot structure a note in such a way as to mask equity participation by altering the return based on deal profitability.

Self-directed IRA plans are a way to diversify tax-sheltered retirement savings. IRS rules surrounding keeping that tax-sheltered status dictate that all activities be exclusively for the benefit of the IRA and conducted at arm's length. Think of yourself as a fund manager putting capital to work and you will be in the right frame. Don't think of "how can I get my hands on this money" for my deals, as that will lead to problems.

@Sean H. , it is certainly easier to use your IRA (Self-Directed IRA) as just a lender in another property. You would only need to find a custodian that holds promissory notes, draft the note with the borrower, and fund. They would then pay back your IRA according to the terms of the note agreement. If you were thinking about using your IRA to loan money on a property that you are personally buying, then you would not be able to do that. That's considered self-dealing because you can't use your IRA to personally benefit yourself.

What you can do is buy the property with the IRA directly or through a single-member LLC (sometimes marketed as IRA LLCs). The IRA (or the LLC) would then own the property, pay any expenses for rehab/maintenance, and collect any rental income or sales proceeds. If the IRA (or LLC) does own the property, then you personally can't do any of the work on the rehab/maintenance. That's considered putting sweat equity into the asset and that's not allowed. What you can do is manage the rehab and make investment decisions, but the extent of your involvement needs to end before you're actually swinging a hammer.

If you were to take money from a non-family third-party (can't be a disqualified individual) through their IRA then that would be fine. They could essentially lend your LLC or send money to the title company directly and be the mortgage holder. If you go this route, you'll need to outline how the payoff is going to occur. You don't necessarily need to have a specific interest rate defined but you will need to have the terms of the payoff (i.e. splitting the proceeds of the gain on the sale).

To your third point. Any Self-Directed IRA custodian will be able to set you, or whomever you are working with up with any type of IRA (Traditional, Roth, SIMPLE, & SEP) and that IRA will be able to invest in ‘alternative' type of assets.

@Brian Eastman has outlined some great points on what some of the potential pitfalls are when you use your IRA to invest. With that being said, there are numerous safe and legal ways to do this, and any self-directed IRA custodian can help you with this. When I worked for a trust company that would custody self-directed IRA accounts, I always found it to be the most beneficial to have a phone call to discuss exactly what you're trying to do. While majority of them won't give you tax, legal, or investment advice, they will help educate you on the best way to structure what you're trying to do and point you to resources that are specific to your situation.

@Sean H.

It’s easy to open an SDIRA account with any type Ira. 

@Brian Eastman summed up your answers to your questions very accurately. Continue to Educate yourself because SDIRA is very powerful in building wealth. You will figure out what is best for you. There are many avenues that thousands of our clients make work for them. Clients use their own knowledge and expertise to invest in what they know and understand. 

Thanks for all the help. 

I understand now that is best to not do any work on a property if i have IRA money invested in it. I only do rehabs or new construction, mostly new construction, so i understand this makes a bigger legal headache. Also, im now educated if i mess with an IRA, i can not do profits just pre determined interest rates. Two things to clarify:

If i bought property A, and invested 50k of IRA money with a pre determined interest rate before (say 5%) and created some kind of pre-contractural document, but the rest of the money invested was from my own cash supply can i mix in this way. Can you mix money like that?

If I bought property B, and my GF decided to invest 50k of IRA money with a precontractural interest rate, with this prevent her from investing anymore money of her normal cash in property B? Or can just invest IRA money into that property to not muddy the waters. Also, i would want to make sure my gf qualifies as a lender. We have the same address, but we're not legally bound.

In each of these examples the property would be in my name.