Real Estate Investor · Seabrook, TX · Member since 2015 · 37 posts · 6 votes
Hello everyone. Thanks for all of the great info on these forums.
A little history....
I have a decent job that I don't want to leave anytime soon, but I realize that I am not going to have the kind of retirement I want unless I start taking better control of my retirement money. I have almost 300k sitting in some old retirement accounts. They haven't been growing very much and I'd like to use that money to invest in real estate. I was once an accidental landlord because I kept a home I had when I moved and rented it out. I made many typical mistakes, including renting to family.
I've been puzzling over the solo 401k and solo IRA options that some people are recommending and I'm having trouble working through the numbers, so I have a few questions.
1. Is the amount lost to immediate taxes and penalties really that detrimental over the life of the investment when you take into account the ability to do your own work on properties (cheaper) and things like depreciation. What about the UBIT? Does that change the analysis? If you are holding in an LLC, doesn't it have to pay some taxes?
2. Is it really possible to get non-recourse financing for properties held by the retirement account? How hard is it to find those banks? How onerous is it? How much extra in interest rate and how much less LTV will they loan?
3. The Roth versions seem like interesting options. How well do they protect all of the income and profit from appreciation?
I'm interested in this exercise as well. I don't have the credentials to give you any advice, just trying to clarify the question. So for the sake of your side-by-side comparison, you want to figure out the after-tax value of $300,000 at retirement, with the constants you've established:
Purchase real estate (as opposed to notes, tax liens, etc) by leveraging $300,000 currently held in a retirement account
Assuming a 33% tax & penalties loss for all distributions.
Assume that the investment would perform equally in both scenarios, with the following exceptions:
Property held in retirement funds require using an unrelated party for maintenance and other "blue collar" tasks. Have you put a price tag on your labor vs contracted labor? Give us your best estimate of the percentage to include in the maintenance/repair/replacement costs
Property held in an SDIRA would require setup and administration fees, including the establishment of an LLC for greater check control, as you mentioned. Has someone out there determined a reasonable cost for this as a percentage of Gross Income?
If could establish a simple business and qualify for a Solo 401k instead, theoretically you could dispense with the LLC and save on some of those setup and administration costs. Anyone want to throw out a theoretical cost difference between SDIRA/LLC vs Solo 401k setup and administration? You would want to include the cost of UBIT in the IRA option.
What else?
For capital gains, with the retirement account your pre-tax appreciation dollars are taxed at retirement. On the other hand, your post-tax Roth, and a little less than $500,000 of your post-tax non-retirement dollars (if you choose to 1031-exchange your way into your eventual retirement home and use the Section 121 exclusion), would be tax-free. You would have to assign a value to the cost of taxing your retirement dollars now or later.
For depreciation, you're deferring post-tax/penalty dollars that will be repaid at retirement (assuming you want to actually spend your retirement funds and not just 1031 them till death and take advantage of stepped-up basis). I'm curious to see a calculation that accounts for this over time. As best as I can see, that $800,000 investment should spit back at least $20,000 in depreciation deductions each year, which pays for your $100k tax/penalty for the early distribution in about five years and could be leveraged into an additional $80,000 of property each year. At retirement, your recapture rate would be 25% verses whatever your retirement distribution tax rate would be.
In either case you get to borrow from the IRS, so you would have to decide if that $20k/year loan outside the retirement account is better or worse than the tax-deferred loan you'd be paying back with 10% interest by taking the early distribution
Finally, there's the marriage consideration. If my wife found out I was making an early distribution from my 401k/IRA to invest in real estate, given the questionable purchases I've made thus far, I would be made to sleep outside of our owner-occupied primary residence and be highly depreciated.
The topic of Solo 401k/IRA is quite popular here, so perhaps you can do a quick search to see others' experience with this.
To answer your questions:
1. Both Solo 401k and self-directed IRA are tax-deferred, so you don't have to pay taxes until the time of withdrawal. UBIT only applies if you use non-recourse financing to fund your property purchase with an IRA. This does not apply to a Solo 401k.
2. Yes, it is possible. Typically you need a higher down payment for non-recourse loans.
3. With a Roth account, because the amount coming in is after-tax, there is no tax on the gains and profits.
One thing to consider is that for a Solo 401k you have to have some kind of self-employed business activity to qualify, either owning a business or working as an independent contractor (part-time is ok). You mentioned that you are not planning to leave your current job, so look into the eligibility to decide if you qualify for the Solo 401k pkan.
Hi Vanessa, sorry, the @ thing just doesn't seem to work for me the way the instructions say it should. Yes I've read many many threads here about sd iras and solo 401ks. What I haven't seen is a sort of side by side analysis. So, let's say that I do have a sd ira and am able to secure no recourse financing. The required down payment on that will be - what?- 35%? 40%? Plus a required percentage for reserves. When comparing that to losing part of your money to taxes and penalties, has anybody looked at the fact that you can use 20% down and aquire more property or maybe the same amount of property but outside of the strictures of a retirement account. Roughly, if you have 300k in the account and could purchase 600k worth of property vs. cashing out and having 200k where you can control 800k of property because you can put less down for each purchase. In other words, how much of a drag on returns is the inability to leverage as much inside the account.
I'm interested in this exercise as well. I don't have the credentials to give you any advice, just trying to clarify the question. So for the sake of your side-by-side comparison, you want to figure out the after-tax value of $300,000 at retirement, with the constants you've established:
Purchase real estate (as opposed to notes, tax liens, etc) by leveraging $300,000 currently held in a retirement account
Assuming a 33% tax & penalties loss for all distributions.
Assume that the investment would perform equally in both scenarios, with the following exceptions:
Property held in retirement funds require using an unrelated party for maintenance and other "blue collar" tasks. Have you put a price tag on your labor vs contracted labor? Give us your best estimate of the percentage to include in the maintenance/repair/replacement costs
Property held in an SDIRA would require setup and administration fees, including the establishment of an LLC for greater check control, as you mentioned. Has someone out there determined a reasonable cost for this as a percentage of Gross Income?
If could establish a simple business and qualify for a Solo 401k instead, theoretically you could dispense with the LLC and save on some of those setup and administration costs. Anyone want to throw out a theoretical cost difference between SDIRA/LLC vs Solo 401k setup and administration? You would want to include the cost of UBIT in the IRA option.
What else?
For capital gains, with the retirement account your pre-tax appreciation dollars are taxed at retirement. On the other hand, your post-tax Roth, and a little less than $500,000 of your post-tax non-retirement dollars (if you choose to 1031-exchange your way into your eventual retirement home and use the Section 121 exclusion), would be tax-free. You would have to assign a value to the cost of taxing your retirement dollars now or later.
For depreciation, you're deferring post-tax/penalty dollars that will be repaid at retirement (assuming you want to actually spend your retirement funds and not just 1031 them till death and take advantage of stepped-up basis). I'm curious to see a calculation that accounts for this over time. As best as I can see, that $800,000 investment should spit back at least $20,000 in depreciation deductions each year, which pays for your $100k tax/penalty for the early distribution in about five years and could be leveraged into an additional $80,000 of property each year. At retirement, your recapture rate would be 25% verses whatever your retirement distribution tax rate would be.
In either case you get to borrow from the IRS, so you would have to decide if that $20k/year loan outside the retirement account is better or worse than the tax-deferred loan you'd be paying back with 10% interest by taking the early distribution
Finally, there's the marriage consideration. If my wife found out I was making an early distribution from my 401k/IRA to invest in real estate, given the questionable purchases I've made thus far, I would be made to sleep outside of our owner-occupied primary residence and be highly depreciated.
@Mark Nolan Thanks, I had seen that. There's a lot of good general information. I just still haven't seen anybody run the numbers all the way out. I've just seen generalizations and summaries. And, honestly, that's fine. That kind of means that there are soooo many variables that it's really really hard to predict which option is better without perfect foresight and a lot of detailed info about the current situation of a given individual.
@Kevin E. I think that I've decided to set aside the analysis for now and am going to just go with the SD IRA. If nothing else, it will keep me from spending the profits! Also, I have to admit that I actually laughed out loud at the marriage comment. My wife agrees that that is a very important consideration.
I did go talk to my accountant about this. He told me that my marginal tax rate is 25% so anything that I distribute is going to cost me at least 35%...and likely more. I think that the actual amount you will lose to taxes up front is key to the calculation, as is the difference is tax rates now vs. when you use the money in retirement. Personally I'd like to be in a higher tax bracket when I retire than I am in now, but....eh....who knows?
For me, right now, I'm engaging with some local real estate agents to begin my search for our first deal rather than continuing with my analysis of the "best" way to proceed. My action plan is to:
1. provide my criteria to a few agents and start looking at properties
2. figure out which company to use for self-directed ira
3. start talking to property management companies
I'm still not convinced that investing inside an IRA is a good deal (stupid UDFI) but I'd rather start now rather than figure out what sort of business to start to justify a solo 401k...and since I can't figure out the numbers that would lead me to choose definitively disbursement vs. sd-ira, I'm going to just get started with what seems to be the safest choice at this time.
You can own rental property in a SD IRA but it may not be the best choice of investment for a SD IRA. There are many tax advantages to owning rental real estate which are worthless if the property is owned in the IRA since the IRA is a tax advantaged account. Also, the risk of violating the self dealing provisions are quite high if you own the property in the IRA. Every expense must be paid from the IRA and all income must go into the IRA. The penalties for making a mistake are severe.
@Kevin E. I think that I've decided to set aside the analysis for now and am going to just go with the SD IRA. If nothing else, it will keep me from spending the profits! Also, I have to admit that I actually laughed out loud at the marriage comment. My wife agrees that that is a very important consideration.
I did go talk to my accountant about this. He told me that my marginal tax rate is 25% so anything that I distribute is going to cost me at least 35%...and likely more. I think that the actual amount you will lose to taxes up front is key to the calculation, as is the difference is tax rates now vs. when you use the money in retirement. Personally I'd like to be in a higher tax bracket when I retire than I am in now, but....eh....who knows?
For me, right now, I'm engaging with some local real estate agents to begin my search for our first deal rather than continuing with my analysis of the "best" way to proceed. My action plan is to:
1. provide my criteria to a few agents and start looking at properties
2. figure out which company to use for self-directed ira
3. start talking to property management companies
I'm still not convinced that investing inside an IRA is a good deal (stupid UDFI) but I'd rather start now rather than figure out what sort of business to start to justify a solo 401k...and since I can't figure out the numbers that would lead me to choose definitively disbursement vs. sd-ira, I'm going to just get started with what seems to be the safest choice at this time.
If you want to see numbers run, buy the book Leverage Your IRA...Maximize Your Profits with Real Estate. It is available through iralending.com and written by North American Savings Bank. There are charts, spreadsheets and examples by expert CPAs, Attorneys etc. I am merely offering this suggestion. I do not endorse or advocate any of these companies. I too am new at this and have done quite a bit of research. Hope this helps.
@Kevin E. I think that I've decided to set aside the analysis for now and am going to just go with the SD IRA. If nothing else, it will keep me from spending the profits! Also, I have to admit that I actually laughed out loud at the marriage comment. My wife agrees that that is a very important consideration.
I did go talk to my accountant about this. He told me that my marginal tax rate is 25% so anything that I distribute is going to cost me at least 35%...and likely more. I think that the actual amount you will lose to taxes up front is key to the calculation, as is the difference is tax rates now vs. when you use the money in retirement. Personally I'd like to be in a higher tax bracket when I retire than I am in now, but....eh....who knows?
For me, right now, I'm engaging with some local real estate agents to begin my search for our first deal rather than continuing with my analysis of the "best" way to proceed. My action plan is to:
1. provide my criteria to a few agents and start looking at properties
2. figure out which company to use for self-directed ira
3. start talking to property management companies
I'm still not convinced that investing inside an IRA is a good deal (stupid UDFI) but I'd rather start now rather than figure out what sort of business to start to justify a solo 401k...and since I can't figure out the numbers that would lead me to choose definitively disbursement vs. sd-ira, I'm going to just get started with what seems to be the safest choice at this time.
Many investors are unnecessarily afraid of UDFI taxation. The bottom line is that your IRA has the opportunity to leverage and receive a higher rate of a return as a result.
With rental property, the annual impact of the tax is negligible. If you sell a property that still has outstanding debt, the tax bite is a littler higher. However - and this is the important part - you should always be receiving a higher cash-on-cash return for your leveraged IRA dollars than you would with a comparable all-cash purchase in an IRA.
The use of debt financing such as a non-recourse mortgage comes with some administrative overhead, but can improve your returns.
As you research self directed IRA vendors, look for someone who can help you get a full understanding of this concept.
Many investors are unnecessarily afraid of UDFI taxation. The bottom line is that your IRA has the opportunity to leverage and receive a higher rate of a return as a result.
With rental property, the annual impact of the tax is negligible. If you sell a property that still has outstanding debt, the tax bite is a littler higher. However - and this is the important part - you should always be receiving a higher cash-on-cash return for your leveraged IRA dollars than you would with a comparable all-cash purchase in an IRA.
The use of debt financing such as a non-recourse mortgage comes with some administrative overhead, but can improve your returns.
As you research self directed IRA vendors, look for someone who can help you get a full understanding of this concept.
Hi Brian,
Thanks for the info. I plan on using my ira for private investments with builders and rehabbers, and to acquire rental property, so I am kind of a hybrid. :)