5 Ways to Avoid Big Issues When Investing Using Family Money

by | BiggerPockets.com

Over the years, one of the most common questions I receive is, “How did you get started in real estate investing?” I can answer this question in a lot of different ways. But to be perfectly honest, we would have never been able to get going if it were not for my father-in-law (future father-in-law at the time). He loaned me (and my then-fiance Liz) $30,000 to buy our first investment property, which was a duplex in Philadelphia, 12 years ago.

Related: How to Win Over Private Money Lenders or Partners for Your Deals

This was the beginning of our investing career and also the beginning of utilizing family members’ money and private money to buy investment property. Most often when you get started and are growing your investing business, family is a likely place to go in order to pool money together for down payments and equity. And it makes sense since family members already trust you. Having family loan you money or become partners with you in your projects can be incredibly helpful for your growth. However, investing with your family’s money can also cause problems and issues. The last thing you want to do is get your family member into a deal and then lose their money.

Related: How I Find Private Money Lenders to 100% Fund My Deals (& How You Can, Too)

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5 Tips to Avoid Issues When Investing With Family Money

There are a ton of do’s and don’ts when it comes to this topic of investing with family member’s money. Hopefully these five tips help you avoid any problems down the road.

  1. Put everything in writing.
  2. Have an exit strategy.
  3. Send regular updates (like you would any other private money investor).
  4. Have a detailed plan in place (don’t just take the money).
  5. Start small and don’t bite off more than you can chew.

Have you ever invested using family money? Why or why not? Any tips you’d add to the list?

Let’s chat in the comments section below!

About Author

Matt Faircloth

In 2005, Matt founded The DeRosa Group along with his wife, Elizabeth. At the time, the two person company owned and managed two assets – a single family home and a duplex. Over the last nine years, they have grown the company to a 12 person team owning and managing over five million dollars in residential and commercial assets throughout the central NJ and Philadelphia area. One of DeRosa’s mantras is “to make money while making a difference.”

12 Comments

  1. Kyle M.

    Any tips for how to help said family members keep their interest income tax efficient? I’ve looked into this using my dad as a private lender but from what I understand he can’t lend me money from an IRA or 401k. It’s a “prohibited transaction”. And if it’s not in a tax advantaged account, it would be taxed at ordinary income levels. Trying to make it a win/win situation.

    • Matt Faircloth

      Hey Kyle,
      Great point. A self-directed IRA is arguably the perfect vehicle for private loans, both for the tax deferment of an IRA and because you can compound the interest on the loan over and over into new loans for exponential returns. The bad part is that you are correct, an investment from your Dad is prohibited into anything you have ownership of. It’s also prohibited for you to invest into one of your dad’s projects with your IRA interestingly enough. That being said he can invest in other people’s projects so one way around it is to find an investor that has the same predicament – a parent that wants to get a return on their IRA but can’t invest with their kids. Your dad would invest with them, their parents could invest with you. I should point out that you can’t link these two transactions, they have to be exclusive of each other meaning if your dad decided to pull out you can’t make that a reason to pull out of the project with the other person’s parents.

      If that seems too complicated you could see if your dad can take a withdrawl or a loan against his IRA to invest with you, both of which are allowed but have penalties or interest associated with them.

      Other options would be to see if your Dad owns his home free and clear or close to it. If so you can put a business equity line of credit on his house for some seed capital, and the equity in his house is probably sitting there not being used anyway.

      I hope that helps!!

      Matt

  2. Clint Landry

    Matt,
    Son and I have done 4 flips in the 150K range then 1 spec in 300K range. I fronted the cash, when completed I my cash back plus interest I lost which was minimal, he got profit. We now have 5 lots paid for to build duplex on each. I have 300K cash, each duplex should be150K. How would structure this where he owns all 5 in the future plus I get my investment back as soon as possible? Both us have other jobs.

    • Matt Faircloth

      Hey Clint,
      I’m glad you and your son are having success! For your land deal, I would think that you could be the bank on the deal and lend him or his LLC the money to build the duplexes and charge a reasonable interest to the project. When the houses are completed and leased he should be able to go out and refinance them which should be easy as he has a full-time job and a W-2. He gets the real estate with a loan on it and you get your money back when he refinances. If he can’t get a loan for all the money you put in he can convert some of your loan to an equity investment and give you some ownership of the properties.
      I hope that helps!
      Matt

  3. Carrie Reyment

    Great article! As we are starting to expand our business we are approaching aunts and uncles about rolling their IRA’s and 401K’s over. I know that there are prohibited transactions with parents, does that apply to other family members? Are there certain IRA’s that parents can use to invest with kids or are all IRA’s and 401K’s off limits? Also, we are putting together a packet for potential investors. I am finding it difficult to easily explain how someone gets a self directed IRA or solo 401k to those potential investors who are unfamiliar with them. Do you have a recommendation on an easy to understand document or flow chart to add in to a presentation or any other recommendations on how to easily explain those options to potential investors?

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