Thinking about rental properties using Self Directed IRA.

[Eric Schwake]

My first post to BP.  Posted the same to Reddit but think there might be some different opinions here.

I've currently got an IRA with Betterment that has around 180K. I've been looking at RE Investing as an option to get my money out of the stock market. I currently have a full time job where I receive pretty decent bonuses and RSU's so long term I'd like to use that income for RE investing but it will probably be at least a year or two before I can do that because I'll probably use that income this year to buy a house for my family.

So short term my idea was to move the money in my Betterment account to a self directed IRA. I then was planning to use the self directed IRA to buy property through Roofstock. Since this will be my first real estate I am trying to do it fairly hands off and the local real estate market where I am doesn't appear great for cheaper rental properties.

As part of this plan I suppose I'd have a couple options. 1) Buy one or two properties using cash from the self directed IRA. 2) Financing 3-4 properties using funds from the self directed IRA. Because I'm new to all of this I tend to favor option one. The other nice thing about that is that I wouldn't have to worry about mortgage payments. I know that having multiple properties through financing has it's benefits in a normal scenario but from what I've read I could have some issues with UBIT if I do that since I'd be using a self directed IRA.

So having said all this does it make sense to move my money out of Betterment and use it for rental property investing? Is it a good idea to use Roofstock especially considering I want to stay fairly hands off and I don't have great property options locally? Should I just wait until I can start doing rental property investing with cash on hand? I do have a couple meetings set up with local CPA's to see what they recommend and I also will be speaking with Roofstock soon to learn more about them as well. I figured I would check with you all though as well to get any advice you have to offer because I know there is a lot of expertise here.

Thanks in advance for all your assistance.

[Lynne Smith]

Hi Eric, welcome to BP. As evidenced, there is a lot to consider. I'm also looking to invest a portion of my IRA funds in real estate and, based on my research, below are some clarifying points.

1. What is taxed?  Keep in mind, the only part of net income that is taxable is the portion financed.  If you finance 50% of the property (with a non-recourse loan), then 50% of the NET profit is taxed after you deduct all expenses and, yes, depreciation from the portion you financed. True, you can't take depreciation for IRA funds used, but you can realize depreciation on the portion financed - which reduces the income subject to taxation. Also, as Brian notes, the tax is pretty low. It's based on the Trust Tax Schedule (which for 2018, looks to be 10% for net income $0-$2500; then 24% between $2501-$9150 etc.) Example: If your property grosses $10,000 and after all deductions (taxes, insurance, repairs, expenses, depreciation) you end up with a net income of $2500, the Unrelated Debt Financed Income (UDFI) portion is 50% or $1250 -- so the tax would be $120.

2. No depreciation in an IRA? True for your IRA funded portion only. For the IRA money used, I grappled with this a bit, but in thinking it through, who cares? We like depreciation because it provides an offset to our taxable income -- so we pay less taxes (assuming your income isn't too high in which case losses are deferred). But if you're in an IRA, all the income made from real estate goes back into the IRA -- so I don't think we lose anything. I'm not paying taxes on any income the IRA generates, so who cares if we can't depreciate? Also even in non-IRA scenarios, we make up the depreciation on the other end (it gets added to cost basis). Playing it out, we retire, start taking distributions from the IRA, the property is paid off (or not), and all the income that's been accumulating over the years is sitting there -- still accumulating from rents coming in. Depending on whether it's a Roth or Traditional IRA, you pay taxes on withdrawals, but you would do this regardless of the IRA investment vehicle.

I love this because unlike the commercials that scare you with asking how long your money will last into retirement, with real estate you have a living entity that generates income as you take it out.  So live to 100 and not worry!  Of course good dividend stocks can also provide income, so good to diversify.   I agree with Brian's point that it boils down to where you want to invest your retirement savings. 

I'm still learning, but it helped to write this out.  I hope it was of some use.   There are some great resources here - https://www.trustetc.com/self-directed-ira/rules/ubit