Using Self Directed IRA to purchase property???

Question

Hi BP, Got a quick question for those experienced w/ Self Directed IRAs... I am looking to purchase my 3rd apt complex. I already put down 10% and started looking for a lender... However it looks like my D/I is slightly higher than what the bank's want. So... My question is: I have 150k in an IRA and if I turn this into a Self Directed IRA to purchase the property the original amount would I be doing a prohibited transaction because I already put down the 10%??? I am still looking for lenders but need to be prepared to look for other options if the lender says no this week. Any thoughts or comments about this would be greatly appreciated. Thanks!

William Morrison · Answer

@Doreen Chaisson great recap. Christian if you would like a good reference I would recommend:Leverage Your IRAby Matthew M. AllenIt's put out by NASB which is involved in lending to Solo 401ks and Checkbook IRA (or IRA LLCs).It's cheapest on their site.It has great charts and tables showing UBIT and UBTI as it relates to an IRA.I've used them for non-recourse loans and I have both 20 year and a 5 year arm depending on the numbers that worked. They base what they'll on rents, value and reserve. 30% down doable but 40% more likely in my case. Rates not too bad either.The 12 month rule Doreen mentioned gets overlooked in many responses I've seen on BP. It's a great point.

Doreen Chaisson · Answer

It's the net income over the course of the year. It is calculated at the end of the year. UBIT tax on rental income applies until the loan is paid off. Every year, the ratio of indebtedness will change as the loan is paid down. Year 1 it may apply to 25% of the net income generated, Year 2 it may drop to 17% of net income, etc. You need a good accountant or CPA to do this calculation as it is quite intricate.Another factor - if your IRA sells the property while the loan is in place, or even up to 12 months after the loan is paid off, your IRA will also have to pay capital gains on the profit. If the IRA sells the property 12 months and 1 day after the loan is paid off, there is no capital gains tax. In a nutshell, the IRS looks at it this way: Your IRA didn't fund 100% of the purchase, it shouldn't be entitled to 100% of the returns until it owns it 100% outright.

William Morrison · Answer

Chad you always want to be able to ask your CPA intelligent questions. And it helps if you're not the first to bring a particular type of tax event to them. Grin. The two books I suggested will help, especially the one by Matthew Allen.You might also like to look at the IRS Form 990-T and the associated Schedule E. You might find it's just like Passive income outside of a IRA with your income above the deduction limits.You can have a negative return and a carry forward. And that's where the 12 month rule Doreen mentioned comes in later and is great for you.Some think because its in an IRA none of the normal real estate tax benefits apply, not so.

Michael Lee · Answer

Hello! If you need the cash I would not recommend it. Otherwise, from what I know, it is a good way to go if you can make it last over 12 months but taxes are not a terrible thing. Especially if it is the only way to do it. If it is a good deal and you are planning on making good money I would do it. Good luck!

Chad C. · Answer

@Doreen Chaisson Thanks for the help Doreen. Much appreciated! Makes a lot of sense.

Christian Sifuentes · Answer

@Doreen Chaisson: can you expound on the UBTI; does that mean that 25 % of the monthly profits will be subject to UBTI tax? Or is it a one time tax event? Hope the question makes sense, trying to understand all this.Thanks

Doreen Chaisson · Answer

Technically your 10% down payment with personal funds disqualifies that property. If you can "unwind" that transaction, rewrite the P&S agreement in the name of your IRA and then have the earnest money sent from your SDIRA, it could work. Will your SDIRA have enough funds to purchase the property outright? If the IRA needs financing, keep in mind you'll need to use a non-recourse loan (NRL). Using an NRL to finance an IRA purchase of RE will trigger a tax called UBIT on the portion of the rental income attributable to the financing. Rough example: your IRA puts down 75% and finances 25% of the purchase. Roughly 25% of the net income, after deductions, will be subject to UBIT tax, which must be paid by your IRA.Most NRLs are 3 - 5 year ARMS, and most lenders require 30%, 40% or more down. They'll also want to see a cash reserve in the IRA to cover any loss of rental income. They'll generally lend on income producing properties only - no raw land, etc. Each has their own specific requirements and exclusions. If your IRA will be using financing, be sure to check with a qualified CPA before proceeding so that you're aware of the impact UBIT may or may not have on your ROI.