Self directed IRA investing

[Kevin Gerace]

I have 30k that in a 401k, that I am going to transfer into a self directed IRA. Can I use this for a down payment on a flip and finance the rest of the purchase price with a conventional mortgage?

[Mike McDermott]

Rodney,

If you do some research, you'll find that Solo or Independent 401Ks are far superior to IRAs. For the most part they escape Unrelated Business Income Tax (UBIT) whereas IRAs always incur it when borrowing money.

In the scenario you've described, it is unlikely that a bank that offers non-recourse loans (NRL) is going to lend you money on a fix and flip. The banks that do offer NRLs require the property to be income producing. So "Rentals - yes, Flips - no."

Keep in mind also that if your retirement plan acquires the house, you can do ABSOLUTELY no work yourself on the property. So to keep your numbers straight, you would need to have and borrow enough for acquisition and renovation using contracted labor.

Now for a real caveat. Fix and flips MAY escape UBIT and they MAY NOT. There are no hard and fast guidelines about this but the magic number seems to be three. If a plan does more than three flips, the IRS may consider your flipping a business rather than holding investments, and they MAY apply UBIT to you. The very worst case scenario is that they deem all flips as business and apply UBIT to everything. The best case scenario that I know of is upon five flips, they allowed three UBIT free, then applied UBIT to the other two. Since there are no codified rules it seems to be up to each individual IRS agent that looks at your file.

Regardless of whether you have to pay UBIT or not, if you flip a house in your 401K, I'll wager your returns will still kill those of mutual funds, CDs, or annuities.

So to sum up:

1. 401Ks escape UBIT when borrowing money. Returns are 30% - 50% greater than the same leveraged transaction in an IRA.

2. NRLs are not available through banks for fix and flips. You can get 3rd party private money or hard money for your project though.

3. A fix-n-flip may incur UBIT regardless of leverage. The magic number seems to be three, but there is no guarantee.

4. Even after incurring UBIT, a real estate transaction beats most other investment vehicles, especially Wall Street dreck, annuities and bank CDs.

Keep up the great work! Don't Occupy Wall Street, Escape Wall Street! Investing in Main Street creates good housing, jobs, and gives you control over your investments and your future.