Investing with Self Directed Retirement Account Funds

Tax, SDIRAs & Cost Segregation
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Investing with Self Directed Retirement Account Funds

Dustin FaethPro Member
Real Estate Investor · Columbus, OH · Member since 2013 · 153 posts · 92 votes

If I have personal retirement funds in a self directed IRA right now, what options do I have for investing this in real estate? And can I use this money to invest in real estate for my own business (to fund rehab costs for my own project, deposit money on a property, etc.)?

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Jon Holdman
Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
13y

Sort of. You can use IRA money to invest in anything except life insurance, collectables and shared in S-corps. You have to have the right custodian. A Fidelity IRA might be called self directed, but they still won't let you buy real estate.

Assuming you have the right custodian, your IRA can buy rentals, do fix and flips or whatever. What it can't do is any transaction with you or other disqualified parties. So, the IRA could be a fixer, fund the fixup and sell it. You could not personally benefit from that, nor could you personally contribute money or labor into that project. The funds for the purchase, rehab, and anything else would need to come from the IRA and all proceeds would go back to the IRA.

With active businesses like fix and flipping, you also incur UBIT (Unrelated Business Income Tax). So, you IRA would need to file tax returns and pay this tax.

It is possible, supposedly, to "partner with your IRA". You put in, say, half the money and the IRA puts in the other half. The partnership does a fix and flip. The net profits would then be split 50/50. All the other rules apply, though.

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  • Jon Holdman
    Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
    13y

    Sort of. You can use IRA money to invest in anything except life insurance, collectables and shared in S-corps. You have to have the right custodian. A Fidelity IRA might be called self directed, but they still won't let you buy real estate.

    Assuming you have the right custodian, your IRA can buy rentals, do fix and flips or whatever. What it can't do is any transaction with you or other disqualified parties. So, the IRA could be a fixer, fund the fixup and sell it. You could not personally benefit from that, nor could you personally contribute money or labor into that project. The funds for the purchase, rehab, and anything else would need to come from the IRA and all proceeds would go back to the IRA.

    With active businesses like fix and flipping, you also incur UBIT (Unrelated Business Income Tax). So, you IRA would need to file tax returns and pay this tax.

    It is possible, supposedly, to "partner with your IRA". You put in, say, half the money and the IRA puts in the other half. The partnership does a fix and flip. The net profits would then be split 50/50. All the other rules apply, though.

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  • Jamaal Hunt
    Wholesaler · Brooklandville, MD · Member since 2013 · 149 posts · 29 votes
    13y

    I just came from a meeting that was discussing this strategy and everything what Mr Holdman talking about is accurate. I was enjoying the meeting alot. We had a "live" transaction where a property was purchased at $51K and 40K in repairs (all from the IRA) 91K in. The property was sold for 125K. Minus expenses and closing costs the profit was about 12K or so. Not too bad. So many strategies to be successful. I need to stay focus on this wholesaling thing. But if there is a way to get the money myself from other peoples IRAs and place it in this account and be successful in flipping I'll wont wholesale too much :)

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  • Jon Holdman
    Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
    13y

    Formatting is going to look bad on this, but I think these are the 2013 trust tax rates, which apply to your IRA if its engaged in any active business, such as fix and flipping:

    2013 Tax Rate Schedule
    income is $0 to $2,450 tax is 15% of the amount over $0
    income is 2,450 to 5,700 tax is $367.50 + 25% of the amount over 2,450
    income is 5,700 to 8,750 tax is 1,180.00 + 28% of the amount over 5,700
    income is 8,750 to 11,950 tax is 2,034.00 + 33% of the amount over 8,750
    income is over 11,950 tax is 3,090.00 + 39.6% of the amount over 11,950

    So, there would be tax of $4,110 on that $12,000 gain on that fix and flip. If the IRA turned around and did a second flip with a gain of $12,000, the tax on that would be $4,752. I think. I tried to puzzle through a form and my head started hurting,

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  • Kaaren HallBusiness Member
    Financial Advisor · Irvine, CA · Member since 2011 · 113 posts · 63 votes
    13y

    You can read more about UBIT (and UDFI) at www.IRS.gov Pub 598

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  • Will BarnardPro Member
    Moderator
    Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
    13y

    And if your IRA account is not held with a true self directed administrator, contact Kaaren Hall , she can help you.

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  • Ravi Renduchintala
    Irvine, CA · Member since 2013 · 6 posts · 0 votes
    13y

    Believe the first part of the question has been replied to. In terms of using the IRA to invest in the business there are some self directed IRA companies that specialize in this by setting up an LLC and making you the managing member. it's a little more expensive to do but can be done.

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  • Hubert Bromma
    Real Estate Lender · Oakland, CA · Member since 2012 · 13 posts · 0 votes
    13y

    Dustin and Jon; I would like to offer the following document to help you understand UBIT (UDFI is also explained):

    [REMOVED]

    There are also some thorough resources available here, including some real estate IRA case studies you can explore for investment ideas, and a report about partnering your IRA.

    Best of luck.

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  • David Beard
    Investor · Cincinnati, OH · Member since 2010 · 1k+ posts · 928 votes
    13y

    Quick question: when you engage in an active business and pay the UBIT, is that taxable income now characterized as "after tax" in your SDIRA, so that later when you start to distribute, you won't pay tax again.

    I'll continue to plug the SD401K rather than SDIRA or SD IRA/LLC. It's unbelievably flexible, you can borrow up to $50K from it for any reason (like any 401K), and you don't incur UBIT if it borrows money to make purchases. You don't deal with these expensive and cumbersome custodians, you run it all out of your local bank account (true checkbook control).

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  • Mike D'ArrigoPro Member
    Turn key provider · San Jose, CA · Member since 2010 · 4k+ posts · 3k+ votes
    13y

    Kaaren Hall has a great report on her website. I'd encourage you to download it and read it.

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  • Kaaren HallBusiness Member
    Financial Advisor · Irvine, CA · Member since 2011 · 113 posts · 63 votes
    13y

    Quick answer: You pay the UBIT now and you pay income tax when you take a distribution.

    The Solo 401(k) is truly a great account, agreed. If you are self-employed with no full-time employees (in any of the companies you own) it is a powerful alternative to the IRA.

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  • Jon Holdman
    Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
    13y

    Nope. Its still taxable when you withdraw the money, if this is a traditional IRA.

    The justification I've seen for this tax is that is levels the playing field with a taxable entity. If you earned money somehow, you would pay tax on it. Then you use it to operate an active business. You pay tax on the net income from the business.

    In any sort of non-taxable entity, you're putting in untaxed money. You use that to operate an active business, generating income. You pay tax on that income. Then you remove the money from the non-taxable entity and you pay tax on when you withdraw. The example used by the IRS is a university operated bookstore vs. a normal (taxable) bookstore. If it was untaxed, the university bookstore would have an advantage over the commercial bookstore.

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  • David Beard
    Investor · Cincinnati, OH · Member since 2010 · 1k+ posts · 928 votes
    13y

    Thanks, Kaaren and Jon, that's what I suspected, and as you walked through it, it makes sense. I had not looked up the rates you shared, Jon, and didn't realize how truly punitive they are. Since 40% of your flipping profits will be disgorged to Uncle Sam, lending really enjoys a huge advantage (and is a lot lower risk).

    As far as the SD401K, anyone involved in real estate can create some sort of active business with minimal effort, there is no minimum size requirement, though some revenue or activity will be necessary to see on a Schedule C or similar business tax filing. To me, it's an absolute slam dunk to go that route, and you can roll over all your old company 401K's, pension plan distributions, and other IRAs.

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  • Jon Holdman
    Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
    13y

    Can you set up a Solo 401k even if you have a day job and are covered by your employer's 401k plan?

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  • David Beard
    Investor · Cincinnati, OH · Member since 2010 · 1k+ posts · 928 votes
    13y

    Absolutely you can. Pay a $595 one-time fee to establish the plan, and $120/year to the plan administrator (or optionally $395 one time and $190/year). No LLC to maintain and pay state fees for, just a simple informational tax form if plan assets are greater than $250K. My administrator will even handle the administration of loans if you choose to borrow from your plan, at no additional cost.

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  • Mark Forest
    Real Estate Investor · Fenton, MI · Member since 2008 · 946 posts · 153 votes
    13y

    Since you cannot save money by doing your own labor or even management of the property it means you will have to pay an IRA manager, property managers, contractors, etc. using your IRA money. Why should anyone do this?

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  • Mike G.
    Rehabber / Flipper · Simi Valley, CA · Member since 2010 · 597 posts · 259 votes
    13y
    Originally posted by Jon Holdman:
    It is possible, supposedly, to "partner with your IRA". You put in, say, half the money and the IRA puts in the other half. The partnership does a fix and flip. The net profits would then be split 50/50.

    Is this true? I thought you could only do this if you start the business with the IRA as a partner. But if your business already exists, you cannot use funds from your IRA for a flip. Is that not right?

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  • Kaaren HallBusiness Member
    Financial Advisor · Irvine, CA · Member since 2011 · 113 posts · 63 votes
    13y

    Q - Can you set up a Solo 401k even if you have a day job and are covered by your employer's 401k plan?

    A - Yes you can - as long as you are self-employed as well. Check with your tax professional to confirm.

    Q - Since you cannot save money by doing your own labor or even management of the property it means you will have to pay an IRA manager, property managers, contractors, etc. using your IRA money. Why should anyone do this?

    A - You are allowed to screen tenants, collect rent checks and hire third-party vendors to do the work on your IRA-owned properties. You may not need a property manager. Begin with the end in mind and pencil out the ROI before investing. Real estate is certainly an asset with a lot of expenses, not just property management expenses.

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    1Reply
  • Kaaren HallBusiness Member
    Financial Advisor · Irvine, CA · Member since 2011 · 113 posts · 63 votes
    13y

    Q - It is possible, supposedly, to "partner with your IRA". You put in, say, half the money and the IRA puts in the other half. The partnership does a fix and flip. The net profits would then be split 50/50.

    Is this true? I thought you could only do this if you start the business with the IRA as a partner. But if your business already exists, you cannot use funds from your IRA for a flip. Is that not right?

    A - DOL ruling 2000-10 allows you to partner with your IRA but I wouldn't do it. There are special circumstances under which it is allowed. Otherwise it's self-dealing and a prohibited transaction.

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    1Reply
  • Catherine Wynne
    Lafayette, CO · Member since 2009 · 6 posts · 4 votes
    13y

    It's true that your IRA can partner with another person, entity, or IRA. In partnering as tenants-in-common, the IRA would own an undivided percentage of the property and the remaining portion would be owned by the other person/entity/IRA. You may partner your IRA with personal funds and/or disqualified persons, but some restrictions apply.

    One major restriction is when your IRA partners with disqualified persons, the ownership percentage must be kept constant throughout the life of the investment, and all expenses and income must be split according to that ratio. Each bill must be paid according to the ownership ratio.

    For instance, if you and your IRA each purchase half a real estate asset (i.e. are tenants-in-common on the deed), any renovation or fix-up costs must also be split in half. Conversely, any income from the property must also be split in half (half to the IRA and half to the other owner).

    You don't need to use an LLC when partnering with your IRA to purchase real estate. You can choose to do that, but the IRS does not require an LLC or other entity to partner funds.

    1Reply
  • Michael Lleverino
    SFR Investor · Buda, TX · Member since 2013 · 27 posts · 3 votes
    13y

    If you use a SD401k to purchase RE,

    1. Do you lose the benefit of tax deductions?

    2. If yes, would it make more sense to purchase the property outside the retirement account to be able to use the deductions?

    3. Does the RE purchase require it be a non-recourse loan in order to be leverage-able?

    0Reply
  • David Beard
    Investor · Cincinnati, OH · Member since 2010 · 1k+ posts · 928 votes
    13y

    @Michael Lleverino

    1. There is no benefit to depreciation, which is the primary non-cash tax deduction.

    2. Yes, it would make sense to purchase in your taxable accounts, all things being equal, in order to use depreciation.

    3. Yes, must be non-recourse. However, a SD401k doesn't have to pay UDFI tax, so this is a significant advantage relative to SDIRAs.

    Unlike an SDIRA, you can also borrow from your SD401k (up to lesser of 50k or 50% of balance) and use the funds for anything you want, such as to purchase (or use as a down payment in purchasing) property in your taxable account.

    1Reply
  • Catherine Wynne
    Lafayette, CO · Member since 2009 · 6 posts · 4 votes
    13y

    Rather than giving up the depreciation tax advantage, you are trading it for a different tax advantage when you invest in real estate with an SDIRA or SD401k

    Real estate purchased in a retirement account carries its own significant tax advantage. For instance, money in a Traditional IRA has already been 100% deducted at the time of contribution, thus there is no basis left for an individual to deduct. Money made in a Roth IRA, though not deducted when contributed,
    is tax free for the future. In either case, the tax advantage of the account makes it unnecessary to depreciate the property over 27 years or more.

    Comparing post tax money in your pocket to pre-tax or tax-deferred money in your retirement plan is not comparing apples to apples. In some cases, because the money has already been contributed to the account, the investor is comparing the ramifications of distribution first and then investing versus no immediate tax or penalty and creating the greatest returns on those already-contributed funds. Since the tax advantaged money in the plan is, in effect, not
    yours until you take it out of the plan, the real goal is your overall investing and tax strategy for your lifetime.

    1Reply
  • Michael Lleverino
    SFR Investor · Buda, TX · Member since 2013 · 27 posts · 3 votes
    13y

    @David Beard and @Catherine Wynne ,

    Thank you for your explanations!

    0Reply
  • Will BarnardPro Member
    Moderator
    Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
    13y

    Catherine makes some great points here, but keep in mind that losing the tax advantage of depreciation is only one disadvantage and not really the most important one. The best advantage of RE is the ability and ease of leverage. In a SDIRA or 401k, leverage is difficult at best and highly restrictive, i.e. must be non-recourse, non-recourse lenders few and hard to find, lenders require significantly more down, UBIT resulting from UDFI (401k exempt from that), and the list goes on.

    Therefore, the highest and best use of retirement account funds (in my opinion) is to invest in notes and as a private lender investing in trust deeds. This avoids all the prohibited transactions like management issues, repairs, etc. though you still must not purchase a note from a disqualified party or lend to a disqualified party. That remains true no matter what you invest in.

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  • Dennis Tierney
    Investor · Omaha, NE · Member since 2011 · 475 posts · 211 votes
    13y

    Will and I will have to agreed to disagree. I have owned apartments in a SDIRA since 2007 and yes they have nonrecourse loans and I'm happy that I have guaranteed equity gain every month by the tenants paying down the loan. One of the biggest advantges that is rarely mentioned on biggerpockets is the diversification of assets that a real estate IRA allows you and is the main reason I did it. I no longer fear a big drop in the stock market as most people do who are dependnet on the market for their retirement funds. I would have lost a lot of $ in 2008 if I had not made the move to have a SDIRA and retirement would be a lot scarier if I had to depend on the market.

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