Using $$ from IRA as downpayment on a STR?

Question

I've been considering purchasing a vacation rental property, but I would be using money from my SDIRA account for the down payment in order to get started.  It would be an early withdrawal so I know I would be hit with a 10% penalty in addition to being taxed on the money that I would be taking out.  I'm looking in very well-established vacation rental markets.  I've run various calculations on what the value of my downpayment money would be over a 5, 10, 15, and 20-year period based on just leaving it untouched in the IRA vs. using it to invest in a STR and in almost all cases the STR outperforms, unless it just massively underperforms.  Has anyone ever done this before?  Just looking to get some feedback from the community on if this is a good idea or not.

Brett Synicky · Answer

Nope. Set up a checkbook ira or solo 401k and invest in real estate if you want to use ira money. Or as @Nicholas L. stated just save up the money and then do it. Don’t rob your retirement account.

Ned Carey · Answer

@Brian Wendel you have to run the actual numbers on this particular deal to know for sure. But I am also a no, in that I wouldn't take the time to even calculate the number.

Why would you  not use our SDIRA to buy it directly instead of withdrawing the money.

Nicholas L. · Answer

@Brian Wendel

probably not.  no offense, i'm just going to ask - what makes you think that you will be a successful enough STR operator to justify taking the hit?  If you're looking in established markets there is going to be tremendous competition.

and... why can't you just save up enough in cash for the down payment?  if the only funds you have are in a SDIRA then you probably need to be better capitalized anyway before you start.

hope this helps

Ned Carey · Answer

@Collin Hays wrote         "Good thinking, but generally, lenders will not loan against retirement accounts."

While true, this is misleading. Lenders may not loan against a retirement account, meaning using the retirement account as collateral against something outside of the retirement account. However there are lenders that will loan to a retirement account. This is harder to find and there is UBIT tax to contend with but it can be done.

Collins post above shows how there is no one right answer. Holding a tax advantaged asset like real estate in a retirement account limits benefits you can receive.  The incredible cost of taxation on long term compounding of returns indicates most should be very cautious about taking money out of a tax advantaged retirement account early.

Brett Synicky · Answer

I agree with much of what you said here. I think (especially in an IRA due to UDFI on leveraged RE) owning real estate is usually not the best way to self direct your retirement. PMLs are usually a much easier way to invest. That said, many people have done really well investing in RE inside their retirement account and whenever people ask me if should use their IRA to invest in real estate I suggest (among other things) they should consider doing so inside and outside of their retirement account due to the different benefits.

Regarding STR, if the ave length of stay is more than 7 days so it's actually closer to mid-term and significant "services" are not provided like local area tours or some other entertainment, then the income should not subject to UBIT. Of course the turnover must be handled by a third party. I would be curious to hear more about what you mean by "fraught with problems"? I actually think it's pretty straightforward...but again I don't necessarily think it's the best type of investment inside of a tax advantaged account. Thanks for the banter.

Basit Siddiqi · Answer

If the numbers work out for you and there is less hassle why not.You are talking about a 10% penalty over a 5-20 year timetable.If your return from the STR can overcome the 10% hit over that timetable it makes sense. On top of that, you can use the earnings from the STR now instead of waiting until you are 59.5 years old.The income tax portion is likely a wash since you are either going to pay income tax now or in the future. I would just try to do it in a year where your income is low or you can take the losses from the rental to offset the retirement distribution. This will atleast reduce the income taxes you will pay.

I will be biased as I have 0% in retirement and 100% in real estate.With that said, I would prolly not do this if this is your first deal. I would do it if real estate prices fall or if you have some experience.

Collin Hays · Answer

Speaking from personal experience, buying and operating a STR via a "checkbook" or "self directed IRA" is fraught with problems and is far more trouble than it's worth.  The rules on all of it are vast and complicated, and your risk of running afoul via prohibited transactions is quite high. It's too unwieldy.

Not a thing in the world wrong with taking money from your IRA, paying the taxes and penalty, and investing the $$ in real estate. I once raided $450K-ish from my IRA, paid all the penalties, and bought two small cabins for cash.  They've produced hundreds of $ thousands since.  No regrets

IRAs and 401Ks are not the holy grail. I consider them to be very limiting in fact, and don't advise people to contribute to them who want to achieve financial independence in their 40s and early 50s.

Collin Hays · Answer

Good thinking, but generally, lenders will not loan against retirement accounts.

Jules Aton · Answer

Third no.

Teresa Boykin · Answer

@Brian Wendel

I agree with a lot of commenters suggesting using a SDIRA to invest in real estate. If you need additional funds, you can also look into a non-recourse loan.

However, I would also double-check the state/local laws against short-term rentals (including anything that's been introduced but not yet passed) to make sure there isn't anything that could negatively affect your potential ROI.

Using $$ from IRA as downpayment on a STR?

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