Here is a summary of my articles on using Self-directed IRAs to invest in real estate followed by typical questions I get asked on a daily basis on my blog from real estate investors.
Summary
3 Ways to Invest in Real Estate with a Self-Directed IRA
Self-Directed IRAs are great for avoiding taxes on gains, especially for flipping properties. It is recommended that you use the SDIRA for real estate transactions that generate immediate (or almost immediate) taxable income (such as flips or options) and generally not buy and hold deals, that already shelter other income via componentizing.
There are three basic ways to purchase real estate with a self directed IRA:
- Purchase with cash
- Partner with family, friends, or business associate
- Borrow money for investment
1) Purchase with Cash
If you have sufficient funds in your self-directed IRA to cover the purchase price, closing costs, taxes, insurance, etc., you can purchase a property outright. All ongoing expenses are paid in total from your self-directed IRA, and all income/profits are returned in total to the IRA.
2) Partner with Family, Friends, and Business Associate
If you don’t have enough funds for a cash purchase, your self-directed IRA can purchase an undivided interest in a property.
For example, with your self-directed IRA, you could partner with a family member, friend, or business associate to purchase a property for $100,000. The friend could provide 70% of the purchase price ($70,000), and your self-directed IRA could purchase the remaining 30% ($30,000).
3) Borrow Money for Investment:
Through your SDIRA, you could get financing such as a mortgage for a real estate deal. You must consider two points when considering this option:
- The loan must be non-recourse – Per IRS regulations, an IRA cannot guarantee a loan or be used as collateral. A non-recourse loan only uses the property for collateral. In the event of default, the lender can collect only the property and cannot go after the IRA itself.
- Tax is due on profits from leveraged real estate – If your IRA uses debt financing such as a loan on a real estate investment, a tax will probably be due on profits. This tax is called unrelated business income tax (UBIT).
Using an LLC Structure with a Self-Directed IRA Plan
I often stress the importance of using LLCs as the best entity structure for your real estate deals. Here’s just another example of how LLCs offer maximum flexibility and protection when using your self-directed IRA to invest.
WHAT ARE THE BENEFITS OF THE LLC?
- The LLC structure offers investment flexibility by simplifying asset titling and allowing for immediate response to investment opportunities.
- The LLC structure also facilitates the pooling of assets with other investors or with the account owner’s discretionary investment money. Pooling opens the door for self-directed investors to participate in larger investment opportunities.
- Finally, the LLC structure offers an additional layer of protection for the Retirement Plan’s assets.
Seven Things Every Real Estate Investor MUST Know about Investing in Real Estate with a Self-Directed IRA
- Your IRA Cannot Purchase Property Owned by You or a Disqualified Person:
- You Cannot Have “Indirect Benefits” from Property Owned by Your Self-Directed IRA
- Real Estate IRA Investments Are Uniquely Titled
- Real Estate in an IRA Can be Purchased without 100% Funding from Your IRA
- IRA Investments that Use Financing Must Pay UBIT
- Real Estate IRA Expenses Must Be Paid from Your IRA
- Real Estate IRA Income Must Return to Your IRA
Questions & Answers
QUESTION 1
“I recently did a hard money loan where I combined multiple self-directed IRA accounts and money from my company as well. Basically, my self-directed Roth, my wife’s IRA, and the balance was from my LLC. My administrator (APS) didn’t have a problem with the loan, but I recently went to lunch with a friend who claims that the IRS frowns upon this. His argument was that I was personally benefiting so the IRS could ultimately unwind the deal. Even though each investor will have equal profits proportional to the interest contributed to the loan.
I plan on doing a lot more deals like this in the future so I want to make sure that I can “top off” loans with my own money when necessary. Does anyone have experience with this? Again, my administrator claims that it is fine. Is my friend just being ultra-safe?”
My Answer:
Prohibited Transactions. Generally, a prohibited transaction is any improper use of your traditional IRA account or annuity by you, your beneficiary, or any disqualified person. Disqualified persons include your fiduciary and members of your family (spouse, ancestor, lineal descendant, and any spouse of a lineal descendant). The following are examples of prohibited transactions with a traditional IRA:
- Borrowing money from it.
- Selling property to it.
- Receiving unreasonable compensation for managing it.
- Using it as security for a loan.
- Buying property for personal use (present or future) with IRA funds.
Your IRA may not buy an investment from or sell an investment to a disqualified person as defined by Internal Revenue Code Section 4975. To do so is known as “self-dealing.”
QUESTION 2
“I am looking at going with the SD 401K, mostly because I am working Fix and Flips and want to have flexibility on deals by borrowing 50K from the 401K. Has anyone compared the SD 401k to the SDIRA? Are there any pitfalls I am missing on the SD 401k? Thanks for your help.”
My Answer:
Well if we are talking about the solo 401k, there are a lot fewer restrictions with a solo 401k than with an SDIRA. The solo 401k does not incur the UDFI (Unrelated Debt-Financed Income), and allows you to invest in a lot more than the SDIRA.
QUESTION 4
“Let’s imagine the following scenario: come across a person who wants to sell his retail store. Let’s say he sells widgets. So, my SD-Roth IRA buys the LLC (Widgets, LLC). I know that in this type of setup, I cannot run the business, so I hired the current store manager to be the required 3rd party manager. Widgets, LLC makes $1000 in gross sales. $500 for rent, $300 for payroll, $100 for utilities, inventory, etc. That leaves $100, which the manager then sends to the SD-Roth IRA. In this scenario, would that mean that the LLC itself shows 0 profit, and at the end of the year, is only liable for the $800 annual fee and payroll taxes on the one employee/manager? Or am I missing something?”
My Answer:
UBIT (Unrelated Business Taxable Income) applies even in a ROTH IRA. The governing factor is that the IRA is now engaged in a business that does not fit with its tax-exempt purpose. A 35% rate so this needs to be planned carefully.
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I address many of these issues in my Wealth Building Plan. Make sure you are getting the best tax advice. Let me evaluate your financial and tax situation, then develop a customized tax strategy just for you. Together, we will come up with a strategic plan designed to answer your questions as you build your own customized wealth-building plan.
