Dead simple legal structures to use IRA in RE?

[Seth C.]

What are the simplest ways that someone can invest IRA capital in RE? Can they make private loans with or without a lien, invest using their own name, a limited partnership, etc? If LLC, does the money have to be passively invested, or can the LLC be closely held? Bring on your solutions!

[Eric Fernwood]

Hello Seth,

Buying properties through your self directed IRA is not too dissimilar from buying properties outside of an IRA. Below are some of the major points to be considered:

• There are very few restrictions as to the type of real estate as long as it is an investment property.
• Properties purchased through your IRA can be financed. The loan must be a "non-recourse loan". Search "ira non recourse loan" and you will find several.
• You can use 1031 Exchanges with properties held in the IRA.
• You can put properties in a LLC within in your IRA for protection.
• You do not hold title directly; a custodial service holds title for you.
• The custodian will be the entity signing the closing documents.
• All actions must be at arms length. This means:
  
  • You must use a property manager; you cannot manage the property yourself.
  • You may not personally do work on the property; a third party has to do it and the invoices paid by the custodian or the property manager.
  • You may not mix personal and IRA funds or the entire transaction may become an "early withdrawal" from your IRA and taxed as such.
  • You must report the market value to the custodian each year.

Rental income flows into your IRA, which you can utilize according to applicable IRA rules. The paperwork is not that different from normally held real estate and the only taxable event would be if you financed the property and then sold it at a profit. The financed portion of the gain would be subject to what is called the Unrelated Business Income Tax or UBIT.

Unrelated Business Income Tax (UBIT)

In most cases, people hold investment properties in their IRA for the income stream, not for flipping, so the UBIT is not typically a factor. However, should you choose to sell a financed investment property, there is a tax due on the financed portion of the gain. For example, suppose you decided to sell a property that was 60% leveraged and after deducting the cost of sales and other expenses you had a UBIT taxable gain of $20,000 and your marginal tax rate at the time of sale is 20%. The tax on the gain would be:

UBIT = $20,000 x 60% x 20% or $2400

Remember that UBIT only applies to financed properties that are sold. Note that if the loan is paid off 12 months prior to the sale, there is on tax since you only pay tax on the leveraged portion of the gain. Also, if you have paid down the loan to the point where you will have to start paying a meaningful amount of UBIT tax, it may be better to consider a 1031 Exchange.

Seth, I hope this helps.