New investor looking for advice on IRA
New to Real Estate · Member since 2020 · 27 posts · 11 votes
Hello everyone,
I have a bit of money in an IRA right now that I would like to eventually use towards the purchase of a rental property. I am looking for advice from other investors who have used their IRA money. What did you do? Did you accept the penalty and take the money out? Did you use a self directed IRA? Thanks!
@Lance Lvovsky ... and I hear from many CPA's who come from the perspective you state. To say you do not want "to get into it", but then make a dismissive assumption of my motivations simply because of my role is a little disingenuous. (I forgive you, but cannot just walk past that).
I also am networked with many CPA's and tax strategists who see things differently than you do. Success comes in many different flavors. Please read my hopefully friendly background on why I consistently say what I say on this topic.
For a high net worth person with large asset values in both tax-sheltered and non-qualified funds, there is some logic to your approach. You want to diversify the entire portfolio and seek maximum tax efficiency for the non-qualified funds when doing so. If the total desired allocation into real estate is met with non-qualified funds, then why overload that asset class by doubling up in the retirement plan?
However, a blanket statement that real estate does not make sense in an IRA simply because it loses certain tax benefits is just not at all meaningful for most investors. It is a discussion of tax theory, but does not apply to practical reality.
If one can grow their IRA consistently by 10-12% year in and year out, do they care about theoretical discussions about comparative tax efficiency? No, they do not. They care that they are getting good growth in the value of their IRA.
The tax treatment of the IRA is what it is, regardless of whether it is invested in stocks, metals, venture capital, real estate, or whatever.
Further, is it any less tax efficient from the perspective of the IRA to invest in real estate than something else? No, it is not. To an IRA when viewed on a standalone basis, the relative tax efficiency of the underlying asset class in the separate, non-qualified world is entirely immaterial.
The single question most relevant to most IRA investors is "how can I best protect and grow my retirement savings?" For someone who understands real estate and may have a good network of trusted professionals they work with, real estate meets that need.
We also have many high net worth clients and their CPA's who do find investing in income property or syndications to be a solid play because they understand real estate and can have more control over outcomes. To an IRA investor, It is the outcomes that matter.
What may have worked for another investor will not necessarily work for you. You need to review your cash flow, tax, and financial needs to determine best approach. I am not an advocate for holding rental real estate in an IRA. You are losing out on the tax benefits of holding rental real estate. Speak to your CPA... that should be a good start.
@Lance Lvovsky While your point about depreciation is technically accurate, it really does not apply. How much depreciation does your IRA get to take advantage of when invested in the stock market?
Comparing investing in an asset within an IRA with investing in that same asset outside of an IRA does not help one to find the best possible way to put the IRA to work, which is what matters. If an IRA invested in real estate, or notes, or whatever, can provide a better mix of control and principal security along with consistently solid returns, then the IRA can outperform what it is doing today.
@Brian Eastman
I disagree with you and I am not here to get into it. I do expect anyone running an IRA firm like yourself to disagree with me. I represent many wealthy clients and none have rental real estate in an IRA. It is simply not the most tax efficient strategy of employing funds.
Thank you everyone. I will talk to a CPA. I also read that its not ideal to invest within the IRA which is what made me wonder what others are doing.
Thank you everyone. I will talk to a CPA. I also read that its not ideal to invest within the IRA which is what made me wonder what others are doing.
CPA is always a smart move. Remember there are other options than just buying property yourself. Notes, Syndications, and Private lending are all used by SDIRA investors very frequently.
Very true! Thanks Taylor
@Lance Lvovsky ... and I hear from many CPA's who come from the perspective you state. To say you do not want "to get into it", but then make a dismissive assumption of my motivations simply because of my role is a little disingenuous. (I forgive you, but cannot just walk past that).
I also am networked with many CPA's and tax strategists who see things differently than you do. Success comes in many different flavors. Please read my hopefully friendly background on why I consistently say what I say on this topic.
For a high net worth person with large asset values in both tax-sheltered and non-qualified funds, there is some logic to your approach. You want to diversify the entire portfolio and seek maximum tax efficiency for the non-qualified funds when doing so. If the total desired allocation into real estate is met with non-qualified funds, then why overload that asset class by doubling up in the retirement plan?
However, a blanket statement that real estate does not make sense in an IRA simply because it loses certain tax benefits is just not at all meaningful for most investors. It is a discussion of tax theory, but does not apply to practical reality.
If one can grow their IRA consistently by 10-12% year in and year out, do they care about theoretical discussions about comparative tax efficiency? No, they do not. They care that they are getting good growth in the value of their IRA.
The tax treatment of the IRA is what it is, regardless of whether it is invested in stocks, metals, venture capital, real estate, or whatever.
Further, is it any less tax efficient from the perspective of the IRA to invest in real estate than something else? No, it is not. To an IRA when viewed on a standalone basis, the relative tax efficiency of the underlying asset class in the separate, non-qualified world is entirely immaterial.
The single question most relevant to most IRA investors is "how can I best protect and grow my retirement savings?" For someone who understands real estate and may have a good network of trusted professionals they work with, real estate meets that need.
We also have many high net worth clients and their CPA's who do find investing in income property or syndications to be a solid play because they understand real estate and can have more control over outcomes. To an IRA investor, It is the outcomes that matter.
@Brian Eastman self directed Roth IRA. Used my IRA and spouses. Each IRA invested in a LLC the two LLCs formed a partnership and invested in a rental property. Very involved and purchase a rehab on the very low end of the market. Required a lot of attention to detail to follow tax code too.
@Alyxandria Welch
I have invested in Real Estate with my IRA for years now. There are a few important points.
1. You need to have a custodian that will allow you to invest in Real Estate. There are a few out there like Entrust and Millenium Trust. Search and find the one that works for you
2. Remember this is in your retirement account and you have to be arms length. Check out FAQs on this and your custodian can guide you. This will keep you out of legal trouble.
3. This is your retirement account so I would play it safe. Though there are some banks that will allow you to finance with a non recourse loan if you do want some leverage.
@Brian Eastman
Doesn't the IRA have something called as UDFI taxes when you buy from the IRA. I thought that could take some hit on the income.
I am researching if solo 401k is a better option?
When an IRA or Solo 401(k) uses debt-financing, UDFI is generated. UDFI is income that is taxable, as it is generated not from the plan capital, but from the borrowed, non-plan capital. An IRA is broadly exposed to this tax for all forms of leverage. A Solo 401(k) has an exemption from taxation on UDFI when the debt instrument is associated with the acquisition of real property.
Not everybody qualifies for a Solo 401(k), however, so you use the plan you fit.
Even in an IRA, the cost impact of the tax is generally negligible for real estate investors. Deductions allow much of the taxable income to be offset. You are still going to see a boost in return based on the use of leverage inside the IRA. The tax represents a bit of friction against that leveraged boost, but by no means does is wipe out that boost.
@Alyxandria Welch Now is a great time to make the choice. Why not both? Pull some funds out of the IRA to invest as cash into a real estate investment and leave some money in a SDIRA or solo 401k to continue to grow through self-directed investments.
With the CARES act there is opportunity now to pull some retirement funds without the 10% penalty and grow those funds outside of a retirement plan if so desired. Tax-savings in a depreciating asset such as real estate can offset any taxes due for the withdrawal as well when done correctly.
Here is a Forbes article demonstrating new changes to IRA withdrawals.
Happy Investing!
Please see the following regarding Considerations re Investing in Real Estate & Considerations re Choosing a Self-directed 401k/Self-directed IRA provider:
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 that 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 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 use 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).
Considerations in Setting up a Solo 401k to invest in real estate:
1. First, you must be eligible to set up a Solo 401k. In order to be eligible, you must be self-employed (e.g. providing goods and/or services through your personal effort), reporting self-employment activity on your taxes (e.g. Schedule C if you a sole proprietor) & you do not have any w-2 employees working for your self-employed business or otherwise.
2. If you are self-employed with no 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. All of the income and expenses will need to flow in and out of the retirement account.
4. 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...
5. You can't live on the property or otherwise use it for personal use.
6. 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. 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. 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).
Considerations in Choosing a Solo 401k Provider:
1. Confirm that the provider has a pristine reputation (e.g. Better Business Bureau reviews, etc.).
2. You may wish to confirm that the new 401k provider has experience with the particular investments in which you intend to invest your retirement funds as you very likely will have questions in terms of the mechanics (e.g. how do you invest in real estate, etc.).
3. You may wish to confirm that the new 401k provider will handle the ongoing compliance support such as any required 5500 filing (e.g. 5500-EZ for a one-participant plan with assets in excess of $250,000), any required tax reporting (e.g. 1099-r in the event of a distribution or in-plan Roth conversion), mandatory plan updates and amendments, etc.
4. If you might take a 401k loan, you may wish to confirm that the new 401k provider will prepare the required 401k participant loan documents.
Here are some issues to consider in choosing a Self-directed IRA provider:
1. In order to have checkbook control, the IRA account will need to be at a trust company that will allow the IRA to invest in an LLC (where you will be the manager and your IRA will be a member - an as manager you will have checkbook access to the LLC bank account). Therefore, you will want to confirm that the trust company allows for investing in an LLC and the associated fees and minimum balance that applies to the IRA account.
2. Confirm that the IRA LLC provider will prepare all of the documents needed to not only form the LLC (articles of organization, SS-4 to obtain an EIN) but also the documents needed by the trust company to process the investment of IRA funds in the LLC.
3. Confirm that the provider has experience with the particular investments in which you intend to invest your retirement funds as you very likely will have questions in terms of the mechanics (e.g. how do you invest in real estate, etc.).
4. Confirm that the provider has a pristine reputation (e.g. Better Business Bureau reviews, etc.).
5. In addition, if you are self-employed with no full-time employees you may wish to consider opening a Solo 401k instead of a self-directed IRA as it has several advantages over an IRA LLC such as much higher contribution limits, direct checkbook control (i.e. no need to have the account at a specialty trust company), ability to take a 401k loan, exclusion from unrelated debt finance income tax with respect to investment in real estate acquired with non-recourse financing, etc.
In addition, please note if you purchase debt-financed real estate with your IRA, unrelated debt finance income tax should apply to the income attributable to debt-financed real estate held by your IRA. Of course, you will want to review your specific situation with your tax advisor.
The Solo 401k does offer a few benefits over an IRA. Compared to the self-directed IRA, Solo 401k contribution limits are roughly ten times higher and there is no custodial requirement for the 401k. This means you don't need the additional expense and administration of an LLC to have checkbook control. You can take participant loans from a Solo 401k, but not an IRA. Built-in Roth components, spousal contributions, and an exemption from UDFI on leveraged real estate also apply to the Solo 401k. Solo 401k plans are often quicker to setup and cost less money over time compared to most self-directed IRAs. That said, if you are not self-employed or are otherwise ineligible for a Solo 401k plan, the self-directed IRA is the way to go.
So much great information to consider. Thanks everyone! I appreciate everyone's insight on the different routes I can take.
@Alyxandria Welch
I spoke with my CPA, and my IRA "advisor" who is a CFP. I explained my plan to both of them. Showed them the numbers on the deal. They both agreed that cashing out a chunk of my IRA and paying the penalty was not conventional, but that the numbers worked and supported my decision.
Make a plan. Have a conversation. And see what happens. The numbers will either support you or they won’t.
@Account Closed, curious, what makes pulling money out of an IRa/ Solo to invest in RE advantageous to tax free gains and income within a retirement account?
@Todd Goedeke
Sooner or later you have to pay the taxes. When you pull the money out in the future you will likely be in a higher tax bracket. So you save money today, but pay more taxes later. So the tax benefits are not as big of a deal as everyone makes them out to be.
The next part is return. Look at the return you are expected to get in your retirement account vs the return you expect on your real estate investment. Not too hard to make the leap.
My final reason is generating passive income today that I can reinvest I'm my real estate portfolio. Using leverage to grow faster and bigger than my IRA ever would or could.
@Account Closed, aRoth IRA or Roth portion of Solo 401k is 100% tax free forever. Passive income can be reinvested in more properties and other investments if desired. You can use leverage with no tax disadvantages in a Solo 401k.
Yes, IRAs can be transferred to Solo 401k.
@Account Closed, RE owned in a Retirement plan has a higher after tax return than RE owned outside a plan .
@Todd Goedeke
You pay taxes when you take the money out at retirement. Nothing is tax free forever. You either pay now, or you pay later.
@Todd Goedeke. Also I am not a financial expert, and I try not to play one on TV. All I can tell you is that I reviewed the numbers with my two guys. In my specific situation, with my specific deals, and it made sense. Talk to your CPA and CFP if you have them. If you don’t have them, then get them.
@Account Closed
It seems there is one key difference between your analysis and the point that @Todd Goedeke is making. Your analysis seems to assume that you could not hold real estate in your retirement accounts, while Todd is including the very real possibility of doing so. Your comparison is just as much about real estate vs stocks as it is about IRA investing vs cashing it out. When self-directed IRAs and Solo 401k plans (as well as the possibility for Roth tax treatment) enter the picture, the analysis can change drastically. Perhaps what you did was the best move for you. Other investors should consider ALL of their options before deciding what strategy will work best.