Self directed IRA to save for investment properties?

Question

I have been thinking about starting a self directed IRA to save up for future Realestate investments. Does anyone have experience using self directed IRAs? What are the pros and cons?

George Blower · Answer

@Jayson Bell

You can rollover funds from a former employer plan to either a self-directed IRA or Solo 401k (if you qualify) to invest those funds in real estate.

There are certain advantages of setting up a Solo 401k instead of a Self-directed IRA (if you are eligible to do so). Please see more below:

Solo 401k vs Self-directed IRA:

A Solo 401k has several advantages as compared to a Self-Directed IRA including the following which specifically apply to your situation:

• Unlike a Self-directed IRA, you can have the account for the Solo 401k at a bank or brokerage that does not charge maintenance fees and where you will have checkbook control.
• Unlike a Self-directed IRA, if you use leverage (which must be non-recourse financing in either case) to acquire real estate with your Solo 401k the income will not be subject to Unrelated Debt Finance Income tax

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 which 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 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... 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.

Jaysen Medhurst · Answer

I don't think that a self-directed IRA is the best choice here, @Jayson Bell. Sure the contributions are pre-tax, which is great, but there are a lot of hoops to jump through and restrictions. For one, the account "owns" the property. You can't "profit" one thin dime, all the money goes back into the account. You can't touch it until retirement. It certainly isn't a path to financial freedom, if that's your goal.

You have a whole extra layer with the company that holds your account, which obviously adds costs.

You won't get the best mortgage terms, even on a residential property.

I suggest just saving up and socking the money away in index funds. Keep a sell order in place at 5-10% below the current price to minimize downside risk.

Brian Eastman · Answer

@Jayson Bell

A self-directed IRA is not typically a "starter" vehicle.  Accumulate tax-sheltered savings separately in your employer plan.  Perhaps contribute separately to an IRA with a mainstream firm as well.

Once you have a meaningful amount of saved capital, a self-directed IRA would give you the ability to diversify some or all of that tax-sheltered savings away from market based investments and into real estate (or similar).

Jayson Bell · Answer

@Haydn Zeis I do currently have 401k (TSP) from my employer. I do not own any realestate at this point but am looking at purchasing 1st property in the next couple month with funds already saved My thought was to save in self directed IRA untill I had enough money to buy. Given the restrictions it does not sound like I could benefit from cash flow untill retirement. Does not sound like this is the right choice early in my investing career.

Rodney Miller · Answer

@Jayson Bell Hard money lending is a great way to leverage your self directed IRA.  Good luck

Maggie Polisano · Answer

@Jayson Bell

I think self-directed IRA's are a great way to diversify your investment portfolio. Its important to keep in mind the purpose of an IRA is for retirement, so as @Jaysen Medhurst indicates, the income always flows back into the IRA, which can be taken personally through the process of a distribution.

There are many different ways and structures to invest in real estate with a self-directed IRA that do not involve a mortgage. Your personal preferences and investment strategies would help determine if self-directed investing is right for you. The specific Pro's and Cons also would depend on your personal investing strategy.

Haydn Zeis · Answer

@Jayson Bell utilizing your SDIRA is a great way to diversify an existing retirement portfolio.  We have plenty of investors who invest in our investment fund using their SDIRA; especially now that the stock market is so high.  However, as @Jaysen Medhurst stated you can't benefit from the account until you're 59.5.

To answer your question, we'd really need to know more.  Do you currently have rental property or retirement savings, like an old 401k from a previous employer, etc.

Self directed IRA to save for investment properties?

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