What would you do? Wait? Or use your IRA now?

Question

I have one property with a partner that we paid cash with.  It is a modest $300/mo for each of us.

NOW - i have an IRA that i would love to use on a couple of duplexes to really get my feet wet individually.  but i am curious if you would do this for this type of deal.

2 duplexes sold as a package.

Total for both - 100,000

Total rents - 2400/mo

Total water bills - 200/mo

Management if i dont want to - 240/mo

NOI - 1960

My mortgage, taxes, insurance - 680

Cash flow - about 1280.

Down payment with closing would be $33,000.

Now in order to fund the down payment, i would need to take the funds out of my IRA and pay the taxes on that and penalties of 10%.

All the numbers on the deal look great, but i am not sure how to look at the cashing in the IRA part.  This property looks like it would make way more than the money being in my IRA.

I would then have decent cash flow for a year or two until i can save up another down payment.

What do you think?

Will Barnard · Answer

Cashing in your IRA and paying the taxes plus 10% penalty would be a very poor choice in my opinion and I am sure your accountant would agree with me. Now, if your IRA is under-performing, convert to self directed and invest in RE. I realize you can't use that income which is your immediate goal, however, for long term planning, that is the wise choice. For immediate cash flow to replace your W-2 income, you need to start a real estate business. Why can't you get a bank loan for the acquisition, or continue partnering and build up your inventory of cash flow properties?

Also, to be clear and this is VERY IMPORTANT - your numbers above are NOT accurate. NOI is your net operating income after all operating expenses (you did not list them all) and therefore, your NOI is higher than the actual would be. Taxes, insurance, repairs, maintenance fees, legal costs, professional accounting fees, evictions, loss to rent, utilities, etc. are all operating costs that should be deducted. The only costs that are NOT included in operating costs are debt service (principle and interest), capital expenses (new roof, new water heater, new HVAC, etc), and taxes and depreciation.

After including all operating expenses, your NOI would be much closer to $1200 and then you deduct the mortgage payment (remember the taxes and insurance are already accounted for). If your mortgage is $500, then your actual cash flow would be $700. You would then want to pile away at least $120 of that for capital reserves (5% of gross income - this is  bare minimum) so your actual spending money before income taxes would be $580. That is still very good for only 2 units so your deal is certainly a great one assuming it does not have  large mount of deferred maintenance adding to your purchase costs.

Jeff Rabinowitz · Answer

Have you explored converting your IRA into a self directed IRA? You may not have to pay the taxes and penalty if you do so. If you can convert to a self directed Roth IRA you would have to pay the taxes (not the penalty). The earnings in the SD Roth could be tax free. It would behoove you to consult with an accountant about your specific situation and make sure you understand the rules about self-dealing (what you can and cannot do within an IRA). If you consult with an IRA custodian you should be able to get a good first opinion about your eligibility to do a conversion.

Will Barnard · Answer

Keep in mind your 10% penalty is not the only added cost here. First, you already have income and if that income is say $90k annually, then you cash in your IRA for around $30k, that $30k added income places it in the next federal tax bracket of 28% (up from the 25%). That is a tax of $8400 plus your 10% penalty of $3000 for a total cost to you of $11,400. So your net from the $30k IRA liquidation is only $18,600. Probably not enough to do this deal, right? So now you need to liquidate more and pay even more taxes and penalties.

My point is this: Can't you find another means to fund the acquisition outside of your IRA to do this deal? Think creative here, there are many more ways to do this without touching your IRA. The other harm is that your IRA (your retirement) grows at a smaller rate since you depleted it. Even if you increase taxble spending income from the whole deal, I think you lose out more.

Dale Carlson · Answer

Yea, it really just comes down to the penalty, i think.  You are going to pay the taxes no matter what.  So I am thinking it comes down to the fact that this deal will cost me an extra $3300?  I will have to run the numbers and add that in, i guess.  i am not sure if i am thinking of it correctly, though.

Tim Vallee · Answer

@Dale Carlson

I literally am debating almost this exact situation. I would be borrowing from my 401k or 457 at work. I can take up to $50,000 @ 4% for 5 years. That would make my paycheck $1100 dollars less per paycheck. Ouch. But If the RE property is purchased with enough equity, I could use the BRRR strategy as quickly as possible.

Thank you for posing this question.

Dale Carlson · Answer

That is true, i did not include the cap ex, maint, and vacancy.  There arent other utilities.  I wanted to give you the variables to give a picture.  You can fill in the blanks with typical numbers.  I just want to be clear that it would not be cashing in my entire IRA, it would just be about 10% of it.   It seems like the property is a strong enough property, that i could justify doing it, paying the penalty, and get a great start on the journey.  Over the next 3 years, it would pay for itself, and set me up with more properties?

Dale Carlson · Answer

yea...i did think of that.  However it would not allow me to use the income.  My overall goal is to replace as much as my w2 income as possible as soon as possible.

What would you do? Wait? Or use your IRA now?

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