Multi-Family Investing & Self-Directed IRA's

[Jose Linares]

Happy Sunday BP community! I am currently working towards my first small, multi-family investment (5-10 units) and would like to use a Self-Directed IRA for this first property. As I compare fee schedules between self-directed IRA companies, I noticed there are companies that offer a lower Annual Fee + additional fees per transaction or an Annual Fee based upon Portfolio Value.

Since this is my first investment property, I do not know all the transactions typically involved.  Does anyone have a breakdown on what typical transactions would be involved for multifamily?  Which type of company/fee schedule would be recommended?

To give perspective on the "Portfolio Value", I am currently looking at 5-10 units between $500,000-600,000 and I will utilizing a property management company.  Any input would be greatly appreciated!

[Bernard Reisz]

@Jose Linares

There are many options available when choosing how to self-direct: IRA-based vs. 401k-based, Checkbook-Control vs. Custodian-Control, Custodian vs. Administrator, and so on.

Prior to making any decisions, it's best to first assess all the options. We commonly encounter folks investing in RE with an IRA who would have been better-served by a 401k. (Not everyone qualifies for the 401k). However, as @Alina Trigub pointed out, the 401k is often far superior to the SDIRA.

There's much misconception regarding the role of custodians and administrators, as well as the extent to which they should be relied on for advisory services.

There are many excellent companies, but as the number of custodians/administrators has swelled it has become increasingly difficult to navigate the space. More options promotes competition and is great for consumers, but it's also more to sort through.

The partnering questions relate to "prohibited transactions." Prohibited Transactions: In general, you - as an individual - you should not be a party to any transaction to which your IRA/401k is a party; you should act strictly on behalf of the IRA/401k. The requirement that you not personally guarantee any loans taken by your IRA/401k is a corollary of this rule. There are limited instances in which you can invest alongside your IRA, but it's advisable to err on the side of caution in all circumstances.

@Alina Trigub referenced the UBIT tax that applies under certain circumstances to tax-free entities. Following is an overview of the concepts at play.

UBIT/UBTI/UDFI: Traditional IRAs/401(k)s are tax-deferred and Roth IRAs/401(k)s provide tax-free earnings - with regard to "regular" income tax. However, in some scenarios they are subject to a "special" type of income tax that applies to all tax-advantaged entities: UBIT.

What do these stand for?

UBIT = Unrelated Business Income Tax: This refers to actual IRA tax liability; the amount that it owes to the IRS, based on compressed trust tax rates.

UBTI = Unrelated Business Taxable Income: This is the type of income that generates UBIT liability.

UDFI = Unrelated Debt Financed Income: This is subset of UBTI.

• A leveraged real estate deal may-or-may-not generate UDFI. There are available deductions and exemptions that mitigate the tax exposure.
• Gain upon sale of a leveraged IRA asset is taxed at normal capital gains rates. The extent to which the gain is taxable is based on UDFI calculations. The rate at which such income is taxed is the cap gains rates.

Solo 401k simplifies this, as it's exempt from UDFI on real estate acquisition indebtedness.

@Alina Trigub Appreciate the tag!