Self Directed IRAs used for purchasing properties?

Question

If I roll over a 401k from an old job into a self directed IRA,

Can I take 20K from the IRA and use it as a down payment on a property?

The property will cash flow about 200 per month. Is this cash mine to do as I please? Or does that go back into the IRA?

If I sell the property do all the profits go back to the IRA or just the initial 20k?

Does all maintance, taxes and insurance on the property have to come from my IRA?

Jon Holdman · Answer

Its still possible to get leverage in your IRA, just tougher.  And taxed.  But, if you can afford to convert to a Roth, and aren't covered by the various income limitations, that looks like a very attractive way to do it.  The rules about not benefiting yourself in any way at the present time still apply.

Sure seems like the rules on this are fuzzy enough that people are trying to figure out what's allowed and what's not.  Not sure if that means there's a chance to do something now before the IRS figures out a way to close the loopholes, or if there's a chance of getting something that looks OK declared improper.

Brandon Anderson · Answer

Wheatie, thanks for the great post.  I was considering using IRA funds a possible source for improvement funds, but I didn't realize there were such restrictions as having to purchase and fund the ENTIRE house with the IRA.  You may have saved me some big headaches  :D.

N/A N/A · Answer

Wheatie, that seems to be pretty much what the book said. Thanks for posting. Considering the book is aimed at pretty new investors who WILL be hands on, investing with an IRA can be difficult if you follow all of the rules, especially if you want to be a hands on person. To be honest.. for ME, all the hassle wouldn't be worth it. But again, Mike, I never said it was impossible or bad. I was relaying what I read to someone who had a question about it.

Mike Mitchell · Answer

parrot,
I've purchased 2 properties in the past year within my self-directed ira.  The markup on both was huge and they're both financed by me at 12% for 15 years.  The interest alone on those 2 properties over the next 15 years is over $100,000.00.  The markup was $40.000 between the two properties.   All of that money is tax free, no 15% capital gains tax.  What in the world is crappy about that?   You might want to talk to some other guys who are flat making a killing using self directed IRA's before you pass up on such an incredible opportunity  As close as I can tell, I saved $21,000 in taxes.  I can live with that

Jon Holdman · Answer

I'm not an accountant or a lawyer.  But, I've read several books on this topic, including several IRS docs.  I have an investment in a private LLC for self storage using IRA funds.  This is tricky business.  I'm convinced some of the information in books is just plain wrong.

With the right custodian, you can invest in anything not explicitly forbidden.  Explicitly forbidden items include collectables, most metals, and life insurance.  You can't "self deal".  Mostly, that means you can't have your IRA deal with yourself, your descendents or your ancestors.  That means you can't buy a property from your IRA, have your IRA loan you money, or any other transaction where your IRA's on one side and any "forbidden person" is on the other side.  There are a few other forbidden persons, too.

But, siblings and most regular people aren't forbidden.  Real estate is not forbidden.  So, you can indeed buy real estate with your IRA.  Or make mortgages or do hard money lending or buy liens, or lots of other stuff.

All money needs to come from the IRA.  You can't use some IRA money and some of your own money without some additional structure (like tenants in common.)  For example, you can't buy a house with your IRA and then pay to fix the roof out of your own money.  Further, you can't fix the roof yourself.  You can't manage the property yourself.  Any of these things would be considered contributions, and would be subject to the usual IRA contribution limits.  The penalties are really stiff.  If the IRS decides you've handled it improperly, they will declare the entire IRA account (that A stands for arrangment, not account) to be a distribution, and you will owe tax and penalties immediately.  You really cannot be legally involved at all.  Your IRA is a separate entity.

All money produced by the property must go back to the IRA.  You can't touch ANY of it.  If you do, that's a distribution and you now owe taxes and penalties.  That means rent checks must be made payable to your IRA (usually something like XYZ Trust Company Account zzz FBO Your Name), and must go into the acccount.  If someone sends you a check, you cash it, then send a check for the same amount to your IRA, you're in double trouble.  Once for the distribution and a second time for the contribution.

Getting debt in your IRA is tricky.  Since its the IRA borrowing money and not you, you can't contribute in any way.  Like using your credit.  So, it would have to be the IRA doing the loan.  Since the lender cannot come after you personally, it must be a "non recourse" loan.  The only thing the lender can come after is the IRA, which mostly means just the property.  I've not tried, but all my reading says you probably need 30% or more down.

Now, I've read in one book that its possible to partner with your IRA where your are tenants in common and the IRA provides the cash and you provide the credit.  Not totally convinced this is really possible, but I'd sure like to hear about it if someone thinks it is.

One of the kickers, though, is that your IRA is NOT tax free if you have debt.  So, in the example above of using 20K from the IRA for a down payment and get a 90% loan, you're subject to a special not-so-little tax called unrelated debt financed income or UDFI.  This is a specific case of unrelated business taxable income or UBTI, and is subject to unrelated business income tax or UBIT.  This is an old tax put in place to deal with non-profit trusts engaging in ordinary business and having an advantage over for-profit business by not paying any tax.  What this means is that you must pay tax on a fraction of the profits from your debt financed transactions.  That fraction is the amount of debt divided by the basis.  One author I read (Patrick Rice) says when you sell, this fraction is the debt divided by the sales price.  That's sure not how I read the IRS docs.  They're very clear its basis, not sales price.  Since you're depreciating the property, and reducing the basis, the denominator in this fraction gets smaller.  This tax has to be paid out of the IRA.

Then, to rub salt into the wound, you still have to pay tax on your IRA distributions when you do get around to taking them.

So, yes, its possible to do this, but you lose some of the advantages of leverage due to this double taxation.

Now, there's a way to avoid this.  Convert your IRA to a Roth IRA.  Pay the taxes now, and it becomes non taxed.  You don't have to pay tax on your earnings in a Roth and you don't have to pay tax when you take them out.  So, if you can manage to pay the tax right now, this seems like a really powerful way to do RE investments with a retirement account.

So, again, take this with a huge grain of salt.  This is just derived from my reading of various conflicting books and documents.

N/A N/A · Answer

Dude, like I said, read the book. I'm not the financial guru who wrote it so I can't give you any info I didn't read. And the book said it was bad, bad, bad. So check out the book before you act like I was personally attacking anyone who does it because I was not.

N/A N/A · Answer

I suggest you buy The Wall Street Journal's Real Estate Investing Guide. It talks about IRA funded properties, and honestly, it sounds pretty crappy. They recommend you NOT do it.

Richard Warren · Answer

It is my understanding that everything stays in the IRA and expenses come from it.  If you were to take any money it would be a premature distribution subject to taxes and early withdrawal penalty if taken prior to age 59 ½.

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