Using a Self-Directed IRA to invest

Tax, SDIRAs & Cost Segregation
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Using a Self-Directed IRA to invest

Stephen Grindle
Investor · Knoxville, TN · Member since 2018 · 8 posts · 1 vote

Hey friends, 

I'm considering using a Self-Directed IRA to invest in a short-term vacation rental. So two questions:

1. Should I transition my current Traditional IRA to a Self-Directed ROTH IRA or keep it as a Self-Directed TRADITIONAL IRA before investing? I understand that a ROTH allows me to have tax-free gains, but I also know that there are limits on how much I can contribute to this vehicle each year. Wondering if others have experience with this?

2. I've read that my Self-Directed IRA can also own an LLC. I understand the legal protection this can provide when purchasing property, but are there any downsides to purchasing property through an LLC owned by my SDIRA?

Thanks for your help!

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Todd Goedeke
Contractor · Sheboygan, WI · Member since 2016 · 921 posts · 266 votes
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@Stephen Grindle if you are self employed consider rolling over your IRA to a Solo401k. The advantages of using leverage without UDFI implications in a Solo401k can vastly increase your ROI. You can always convert to a Roth within your Solo401k.

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  • Chris SeveneyBusiness Member
    Moderator
    Investor · VA · Member since 2015 · 21k+ posts · 19k+ votes
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    @Stephen Grindle

    1. Converting from one to another really depends on your overall financial situation. I would also run some analytics on it thru excel to see what may end up providing better returns

    2. I can see both arguments of getting a LLC or not. Personally I owned property in my sdira account through the custodian

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  • Brian EastmanPro Member
    Self Directed IRA & 401k Advisor · Wenatchee, WA · Member since 2014 · 2k+ posts · 2k+ votes
    3y

    @Stephen Grindle

    Whether you should perform a Roth conversion or not is not a question that an internet forum can answer.  Please discuss the matter with licensed tax counsel.  There are just too many variables to consider.

    Your IRA can invest in a short term rental, but there are challenges. You may administer your IRA, but may not benefit from or provide services to your IRA. As such, for a high-interaction asset like STR, you will need a property manager. You also want to ensure the STR activity is able to be considered passive rental income and not looked at as a business like a hotel. The presence of additional services or amenities in addition to a place to stay can be differentiating factors between passive/active tax treatment. An IRA is subject to tax on Unrelated Business Income when it engages in a trade or business on a regular or repeated basis.

    With an interactive asset like a STR, having the checkbook control provided by an IRA owned LLC can be a big advantage. You will find it to be much more nimble and cost-effective than relying on a 3rd party custodian to process every transaction related to the IRA's investments.

    2Reply
  • John UnderwoodPro Member
    Investor · Greer, SC · Member since 2014 · 13k+ posts · 17k+ votes
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    1. This is a Rollover not a contribution so no annual limits on amount to rollover. I prefer to invest with tax free money. This makes a huge difference. So I have 2 Self Directed ROTH IRA'S that both own Real Estate. I took the tax hit on the conversion to a ROTH so that I never have pay tax on income or gains in the future.

    2. If you have an SDIRA with checkbook controll, you will have to have an LLC that the IRA owns. A Solo401k just uses a trust account to hold the money.

    1Reply
  • Stephen Grindle
    OP
    Investor · Knoxville, TN · Member since 2018 · 8 posts · 1 vote
    3y
    Quote from @Chris Seveney:

    @Stephen Grindle

    1. Converting from one to another really depends on your overall financial situation. I would also run some analytics on it thru excel to see what may end up providing better returns

    2. I can see both arguments of getting a LLC or not. Personally I owned property in my sdira account through the custodian

     @Chris Seveney, do you have a tool through excel that can do the kinds of calculations you mentioned in your first point above? 

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  • Stephen Grindle
    OP
    Investor · Knoxville, TN · Member since 2018 · 8 posts · 1 vote
    3y
    Quote from @John Underwood:

    1. This is a Rollover not a contribution so no annual limits on amount to rollover. I prefer to invest with tax free money. This makes a huge difference. So I have 2 Self Directed ROTH IRA'S that both own Real Estate. I took the tax hit on the conversion to a ROTH so that I never have pay tax on income or gains in the future.

    2. If you have an SDIRA with checkbook controll, you will have to have an LLC that the IRA owns. A Solo401k just uses a trust account to hold the money.

     @John Underwood, I understand there are no limits on the amount to rollover. But isn't there a $5500 annual contribution limit for ROTH's if I want to throw more money in AFTER the rollover?

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  • Stephen Grindle
    OP
    Investor · Knoxville, TN · Member since 2018 · 8 posts · 1 vote
    3y
    Quote from @Brian Eastman:

    @Stephen Grindle

    Whether you should perform a Roth conversion or not is not a question that an internet forum can answer.  Please discuss the matter with licensed tax counsel.  There are just too many variables to consider.

    Your IRA can invest in a short term rental, but there are challenges. You may administer your IRA, but may not benefit from or provide services to your IRA. As such, for a high-interaction asset like STR, you will need a property manager. You also want to ensure the STR activity is able to be considered passive rental income and not looked at as a business like a hotel. The presence of additional services or amenities in addition to a place to stay can be differentiating factors between passive/active tax treatment. An IRA is subject to tax on Unrelated Business Income when it engages in a trade or business on a regular or repeated basis.

    With an interactive asset like a STR, having the checkbook control provided by an IRA owned LLC can be a big advantage. You will find it to be much more nimble and cost-effective than relying on a 3rd party custodian to process every transaction related to the IRA's investments.

     @Brian Eastman, this is super helpful, especially concerning the STR being at risk of being subject to Unrelated Business Income. I've read a bit about that and I'm still confused about what would create an active tax treatment, but will do more research. Thanks so much for your detailed answer!

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  • Chris SeveneyBusiness Member
    Moderator
    Investor · VA · Member since 2015 · 21k+ posts · 19k+ votes
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    @Stephen Grindle

    I do not but you can probably google it and find one

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  • John UnderwoodPro Member
    Investor · Greer, SC · Member since 2014 · 13k+ posts · 17k+ votes
    3y
    Quote from @Stephen Grindle:
    Quote from @John Underwood:

    1. This is a Rollover not a contribution so no annual limits on amount to rollover. I prefer to invest with tax free money. This makes a huge difference. So I have 2 Self Directed ROTH IRA'S that both own Real Estate. I took the tax hit on the conversion to a ROTH so that I never have pay tax on income or gains in the future.

    2. If you have an SDIRA with checkbook controll, you will have to have an LLC that the IRA owns. A Solo401k just uses a trust account to hold the money.

     @John Underwood, I understand there are no limits on the amount to rollover. But isn't there a $5500 annual contribution limit for ROTH's if I want to throw more money in AFTER the rollover?

    Yes that is true.
    I have never added money to mine because I could grow it so fast with RE investing that I didn't need any contributions.
    One of mine has grown to owning 5 houses so it collects about 6k a month in tax free income. I just bought another house last month with the cash that has accrued. So it keeps growing exponentially.

     
    1Reply
  • Todd Goedeke
    Contractor · Sheboygan, WI · Member since 2016 · 921 posts · 266 votes
    3y

    @Stephen Grindle if you are self employed consider rolling over your IRA to a Solo401k. The advantages of using leverage without UDFI implications in a Solo401k can vastly increase your ROI. You can always convert to a Roth within your Solo401k.

    2Reply
  • Dmitriy Fomichenko
    Solo 401k Expert · Anaheim Hills, CA · Member since 2012 · 18k+ posts · 6k+ votes
    3y

    @Stephen Grindle,

    I don't think anyone on this forum can answer your question if you should perform a Roth conversion. If you get an answer - it would be irrelevant to YOUR situation and completely useless to YOU. Question of Roth conversion is highly personalized and there at least half a dozen questions you need to consider and review with your CPA. 

    The main purpose for having an LLC in an IRA is to provide you with the "checkbook control" over your IRA investments. It allows you to bypass the custodian when making investments and transactions, eliminates transaction-based fees and eliminates time delays associated with having a custodian handle the transaction. The benefits of using IRA LLC structure depend on the types of investments you intend to make with your IRA. 

    I agree with Todd that using self-directed Solo 401k would ultimately be the best option if you are eligible for it. 

    1Reply
  • Jay ThomasPro Member
    Real Estate Agent · Houston, TX · Member since 2021 · 1k+ posts · 715 votes
    3y

    Ultimately, the decision to convert from one type of retirement account to another should be based on an individual's specific financial situation. Carefully analyze the potential benefits and drawbacks of each option before making a decision. Furthermore, running some analytics through excel can help you determine which will provide the best returns. On the other hand, some may prefer to own property in their SDIRA accounts through a custodian. Whichever route you choose, be sure to consider all factors involved. Good luck!

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  • Basit SiddiqiBusiness Member
    Accountant · New York, NY · Member since 2015 · 8k+ posts · 3k+ votes
    3y

    There are annual contribution limits to both a Traditional and Roth IRA.
    Furthermore, a traditional IRA can have both a deductible / non-deductible component(You would need to keep track of your basis in the non-deductible component).

    I personally do not like to invest directly in real estate through a retirement account.

    The issues you will potentially have are
    1) If you have to have excess funds within the retirement account for items such as improvements, tenant turnovers. If you can't afford the cost, you may be required to dispose of the property prematurely. 

    2) If you hold onto the asset into your 70's, you may be required to dispose of the property to pay for RMD's

    Best of luck on your decision.

    [email protected]917-280-8544
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  • Todd Goedeke
    Contractor · Sheboygan, WI · Member since 2016 · 921 posts · 266 votes
    3y

    @Basit Siddiqi You mentioned RMDs as being a deterrent for investing in RE within a IRA/Solo 401k. Are you aware that you can take an RMD as a distribution in kind without liquidating or selling RE? It's done all the time in conversions and when taking RMDs.

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  • Basit SiddiqiBusiness Member
    Accountant · New York, NY · Member since 2015 · 8k+ posts · 3k+ votes
    3y
    Quote from @Todd Goedeke:

    @Basit Siddiqi You mentioned RMDs as being a deterrent for investing in RE within a IRA/Solo 401k. Are you aware that you can take an RMD as a distribution in kind without liquidating or selling RE? It's done all the time in conversions and when taking RMDs.

    I mentioned in my post, you MAY be required to dispose of the property.

    In your situation, if you decide to transfer the real estate, you have three different issues.
    1) You are taking a larger amount out of your retirement account earlier than you may have been required to.(Assuming that real estate is a large percentage of your retirement account).
    2) You are transferring an asset that would be transferred at FMV where the appreciation would be taxed at your marginal tax rate.
    Instead, if you held onto the property within your personal name and then sold, it would be taxed at capital gains tax rates
    3) Transferring a huge property from your retirement account leaves less room for tax planning as you will likely have one year with a tax burden instead of potentially spreading it over several years.
    Maybe you can plan it right by having the distribution in a year where you plan to make $0 other income.

    Talk to your tax advisor.

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  • Todd Goedeke
    Contractor · Sheboygan, WI · Member since 2016 · 921 posts · 266 votes
    3y

    @Basit Siddiqi as I stated earlier you don t have to take out 100% of a RE investment to satisfy a RMD. You can take out percentage of property,25% for example. The IRS also allows a discount of the value due to marketability.

    Several RE tax attys. Have written articles and focused chapters in their books on this strategy.  It’s something a lot of CPAs are not aware of.

    Consult your RE tax attorney for education.

    0Reply
  • John UnderwoodPro Member
    Investor · Greer, SC · Member since 2014 · 13k+ posts · 17k+ votes
    3y
    Quote from @Basit Siddiqi:

    There are annual contribution limits to both a Traditional and Roth IRA.
    Furthermore, a traditional IRA can have both a deductible / non-deductible component(You would need to keep track of your basis in the non-deductible component).

    I personally do not like to invest directly in real estate through a retirement account.

    The issues you will potentially have are
    1) If you have to have excess funds within the retirement account for items such as improvements, tenant turnovers. If you can't afford the cost, you may be required to dispose of the property prematurely. 

    2) If you hold onto the asset into your 70's, you may be required to dispose of the property to pay for RMD's

    Best of luck on your decision.


     1. The rent coming in adds quickly to cash reserves for repairs. 

    2. Both of my SDIRAS are ROTHs so I have no RMD.

    I buy inexpensive properties in both these RUTH'S so I avoid paying huge capital gains or any tax on all the incoming rent.

    Yes you do need to be smart and have some reserves.

    0Reply
  • Bob Floss II
    Attorney · Northbrook, IL · Member since 2017 · 719 posts · 549 votes
    3y

    I would emphasize what John said, be smart and have reserves. Any expenses for the property need to come through the IRA checkbook and not through your personal expenses. The account needs to be able to maintain the property on its own without your help.

    Anyone with a low amount to start may need to think about waiting until you have enough to build a safe reserve in the account or possibly lend to another investor first to get some returns. 

    1Reply
  • Todd Goedeke
    Contractor · Sheboygan, WI · Member since 2016 · 921 posts · 266 votes
    3y

    @Bob Floss II RE ownership in an IRA or Solo 401k need not be delayed because of lack of funds.Another Partner/s capital can be used to purchase a property titled as joint tenants in common. For example,An IRA or Solo 401k may own 30% of a property and a non retirement fund investor may own the other 70% as joint tenants.

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  • Todd Goedeke
    Contractor · Sheboygan, WI · Member since 2016 · 921 posts · 266 votes
    3y

    @John Underwood you don t need to sell a property to satisfy an RMD. You can take a distribution “ in kind” retitling a % or the whole property into a non retirement title.

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  • Jeffrey DixonPro Member
    Irvine, CA · Member since 2014 · 94 posts · 44 votes
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    Roth's and Traditional IRAs have the same contribution limits. 

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  • Roger StPierreBusiness Member
    Lender · Rapid City, SD · Member since 2017 · 30 posts · 20 votes
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    Additionally, if you don't have all cash built up to purchase a rental, you can use leverage via Non Recourse loan. Be aware that the downpayment requirements in this sector are typically 40%. But that does allow one to purchase without having to wait to build up cash. Additionally, the buyer could potentially buy 2 rentals using leverage vs 1 all cash.

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  • Todd Goedeke
    Contractor · Sheboygan, WI · Member since 2016 · 921 posts · 266 votes
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    @Roger StPierre leasing the property to a 3rd party with deep pockets lowers the down payment amount to 20% for non recourse loans.

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