Investing in Self Directed/Real Estate IRA?

Question

I'm interested in hearing about pros and cons from people that have acquired investment properties through an IRA, solo 401K, etc...I'd appreciate any referrals to Real Estate IRA custodians that you work with.

Thanks-

Chris

Thanks-

Chris

George Blower · Answer

@Chris Clark

Please see the following regarding Considerations re Investing in Real Estate & Considerations re Choosing a Solo 401k provider:

General Considerations Re Investing Retirement Funds in Real Estate:

1. If you purchase via an IRA (as opposed to a 401k), you will need to open an IRA account at a specialty trust company that allows for investments in real estate. Unless you invest via an LLC owned by the IRA, you will not have checkbook control over the funds which means you need to run transactions (e.g. income, expenses, etc.) through the trust company who will need time to process the transactions and generally charge fees for each transaction. On the other hand, keep in mind that there are costs associated with maintaining an LLC (such as the $800 annual franchise tax in California).

2. If you are self-employed with no employees, you can set up a Solo 401k through a 401k provider which allows for investing in real estate. In that case, you can simply have the account at a bank or brokerage where you will have direct checkbook control.

3. In either case, all of the income and expenses will need to flow in and out of the retirement account.

4. In either case and if you will use debt to acquire the real estate, it must be non-recourse financing. See more at the following link: https://www.biggerpockets.com/blogs/9552/70408-ira... If debt-financed real estate is acquired via an IRA, any income attributable to such investment will generally be subject to unrelated debt finance income tax.

5. In either case, you can't live on the property or otherwise use it for personal use.

6. In either case, you can't work on the property as it must be a passive investment (e.g. you must hire someone to fix the toilet and can't pay the expense with non-retirement funds).

7. In either case, you must purchase/sell real estate from/to an unrelated person and the real estate can't be titled in your name personally (e.g. in the case of the 401k, it would be titled in the name of the 401k and you would sign as trustee of the 401k).

8. In either case, you should verify that you are eligible to transfer the funds from your existing retirement account (e.g. if the funds are in your current employer 401k, you will likely not be able to transfer until you quit your job).

Considerations in Setting up a Solo 401k to invest in real estate:

1. First, you must be eligible to set up a Solo 401k. In order to be eligible, you must be self-employed (e.g. providing goods and/or services through your personal effort), reporting self-employment activity on your taxes (e.g. Schedule C if you a sole proprietor) & you do not have any w-2 employees working for your self-employed business or otherwise.

2. If you are self-employed with no employees, you can set up a Solo 401k through a 401k provider which allows for investing in real estate. In that case, you can simply have the account at a bank or brokerage where you will have direct checkbook control.

3. All of the income and expenses will need to flow in and out of the retirement account.

4. If you will you debt to acquire the real estate, it must be non-recourse financing. See more at the following link: https://www.biggerpockets.com/blogs/9552/70408-ira...

5. You can't live on the property or otherwise use it for personal use.

6. You can't work on the property as it must be a passive investment (e.g. you must hire someone to fix the toilet and can't pay the expense with non-retirement funds).

7. You must purchase/sell real estate from/to an unrelated person and the real estate can't be titled in your name personally (e.g. in the case of the 401k, it would be titled in the name of the 401k and you would sign as trustee of the 401k).

8. You should verify that you are eligible to transfer the funds from your existing retirement account (e.g. if the funds are in your current employer 401k, you will likely not be able to transfer until you quit your job).

Considerations in Choosing a Solo 401k Provider:

1. Confirm that the provider has a pristine reputation (e.g. Better Business Bureau reviews, etc.).

2. You may wish to confirm that the new 401k provider has experience with the particular investments in which you intend to invest your retirement funds as you very likely will have questions in terms of the mechanics (e.g. how do you invest in real estate, etc.).

3. You may wish to confirm that the new 401k provider will handle the ongoing compliance support such as any required 5500 filing (e.g. 5500-EZ for a one-participant plan with assets in excess of $250,000), any required tax reporting (e.g. 1099-r in the event of a distribution or in-plan Roth conversion), mandatory plan updates and amendments, etc.

4. If you might take a 401k loan, you may wish to confirm that the new 401k provider will prepare the required 401k participant loan documents.

Here are some issues to consider in choosing a Self-directed IRA provider:

1. In order to have checkbook control, the IRA account will need to be at a trust company that will allow the IRA to invest in an LLC (where you will be the manager and your IRA will be a member - an as manager you will have checkbook access to the LLC bank account). Therefore, you will want to confirm that the trust company allows for investing in an LLC and the associated fees and minimum balance that applies to the IRA account.

2. Confirm that the IRA LLC provider will prepare all of the documents needed to not only form the LLC (articles of organization, SS-4 to obtain an EIN) but also the documents needed by the trust company to process the investment of IRA funds in the LLC.

3. Confirm that the provider has experience with the particular investments in which you intend to invest your retirement funds as you very likely will have questions in terms of the mechanics (e.g. how do you invest in real estate, etc.).

4. Confirm that the provider has a pristine reputation (e.g. Better Business Bureau reviews, etc.).

5. In addition, if you are self-employed with no full-time employees you may wish to consider opening a Solo 401k instead of a self-directed IRA as it has several advantages over an IRA LLC such as much higher contribution limits, direct checkbook control (i.e. no need to have the account at a specialty trust company), ability to take a 401k loan, exclusion from unrelated debt finance income tax with respect to investment in real estate acquired with non-recourse financing, etc.

In addition, please note if you purchase debt-financed real estate with your IRA, unrelated debt finance income tax should apply to the income attributable to debt-financed real estate held by your IRA. Of course, you will want to review your specific situation with your tax advisor.

Brian Eastman · Answer

As a plan provider, I cannot make a specific recommendation as to a company to work with per BP guidelines.

We have worked with thousands of investor choosing to diversify their tax-sheltered retirement saving into real estate, and do so with our own plans as well.

What I can help you do, however, is refine your question.

Self-directed IRA's come in several formats offered by different types of companies.  The type of self-directed IRA that will best suit your situation and goals will drive the process of identifying the right firm to work with.

A self-directed IRA custodian is a processing entity.  Think E*Trade or Fidelity with different paperwork.  All IRA based plans are required to have a custodian to administer and report on the account.  What makes a self-directed IRA custodian different is that they are not purely connected to the public exchanges and limited to investing in stocks, bonds and funds, but rather have the staff training and paperwork to document the IRA's investment in the more individualized transactions that occur when investing in real estate, notes and other non-traditional assets.  Such custodians will hold funds, sign documents, issue expenses and receive income on behalf of your IRA and act as your processing layer.  This works OK for relatively static and simple investments like a private placement or crowdfund, but can become rather cumbersome and expensive with a more time sensitive and transaction intensive asset such as a rental property.  You also need to be aware that custodians are passive in nature and simply process transactions at your direction.  They do not provide meaningful oversight or guidance with respect to tax code compliance.

A checkbook IRA LLC is an enhancement on the above structure that is generally more time and cost efficient for investors with a more diverse portfolio.  It starts with a self-directed IRA held by a custodian, but the IRA simply makes one investment into a specially designed LLC entity.  The IRA owns the LLC, but you can be the non-owner manager of the LLC and have signing authority.  This allows you to directly manage transactions via the LLC and eliminates the paperwork, processing delays and per-transaction fees of the custodian.  These plans typically cost a bit more to establish due to the legal work, but in most cases will save you considerably over the long term.  With a quality provider, such plans also come bundled with meaningful consulting guidance to help you get the most out of the program while staying inside the IRS guidelines.

A similar checkbook program is a Solo 401(k).  Such plans are available to those who have some form of self-employment  and no full time employees.  As an owner-only business retirement plan, the Solo 401(k) has higher contribution limits, allowing you to build your savings on the front end as well as providing investment flexibility.  The Solo 401(k) also has the advantage of being more favorable for real estate investments using debt-financing such as a mortgage - as the 401(k) is exempted from a small tax called UDFI that an IRA would pay on the percentage of income derived from the borrowed money.  Your profile indicates you are a realtor, which likely qualifies you for this plan unless you have any full time employees working for you.

So, as you continue your research and get feedback here on BP, think about what type of program will best suit your needs and be sure to ask questions along that line.  Get on the phone and speak with a few of the providers that are active here on BP.  You will pretty quickly be able to tell who is just selling something and who can become a valuable member of your team.

Juan Deshon · Answer

If you are using your IRA passively like Andrea the SDIRA works great with very minor headaches and worries. If you plan to purchase real estate make sure you speak to each custodian on how they let you handle certain situations. What custodians really come down to are the customer service and knowledge of the employees working with you. Some Cons with a SDRA are you cannot have checkbook control, so a high maintenance asset may become cumbersome to maintain under the SDIRA. However there are solutions to make the process feasible. Pro's to the SDIRA is by diversifying the current portfolio you control the return and hopefully it is a good TAX FREE (or deferred at the very least) profit.

Definitely check out the webinars custodians put out there to get first hand look at case studies. I personally use my IRA to invest passively and it has been working great ever since.

Definitely check out the webinars custodians put out there to get first hand look at case studies. I personally use my IRA to invest passively and it has been working great ever since.

Andrea Weule · Answer

Custodians experienced in working with investors (there are many more): New Direction Trust Company, Mountain West IRA, Inc, Quest IRA, Inc., Equity Trust

I'd check out their websites as many offer free webinars and you'll get a good feel for what they offer.

Personally, we've only used ours to invest in syndications and private money lend.  We do not own any properties in our Self Directed ROTH IRA.

Best of Success!

Chris Clark · Answer

@Brian Eastman

Thank you very much for your detailed response.

Chris

Greg Moran · Answer

Howdy Chris,  I use QuestTrust as the custodian for my Self-Directed ROTH IRA, and use it exactly the way @Andrea Weule describes: Private money lending, and starting to explore syndications. As for Pros and Cons: Just like anything you get what you pay for.  The absolute cheapest Custodians, may never have a real person answer the phone, nor would they offer educational webinars or conferences.  I'm very happy with the service I get from QuestTrust, and their fee structure seems fair to me.  They're also very responsive when it comes to funding my deals quickly.  If i have my information in order, it's possible to close a deal in 24 hours.

Investing in Self Directed/Real Estate IRA?

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