Using a self-directed IRA to fund parnership with Contractor

[Joanne Courville]

Hi, I'm new here and have been reading through the threads. I found bits and pieces in relation to answering my question, but hoped I could ask the question here related to my individual situation.

The contractor who I have worked with on my personal home projects is interested in doing some flips and/or buy and holds in New Orleans. I trust him and feel comfortable working with him. He has the expertise (has been in the contracting business for over 20 years) and his wife is a RE agent. He is no relation to me.

However, he needs funding to do the deals. From my perspective, I am looking to grow my retirement nest egg. To fund deals, I would have to do it through an IRA and I'm not exactly sure how to structure such a deal.

Here is what I've learned so far through the threads:

1. Evaluate the appropriate company with who to set-up the IRA. Probably would not want to have check writing privileges as I am new to this and could make some wrong decisions.

2. Appropriate split on renovate and flip is 50/50 for the profit portion.

Questions:

1. How do I pay him his portion of the profits from the IRA...can it just be considered an expense to the project.

2. The contractor said that in some cases we might have to buy and hold. The area he is interested in is in a rougher part of the city, but two new hospitals are being built. It seems that gentrification may happen in the area within the next couple years (unfortunate for the poor who live there). Whole Foods is even opening up a store in the area and I'm sure they have done their market research. We would try and sell at a later date when the medical professionals begin seeking homes.

3. If we do buy and hold, how should he be compensated during the holding process?

4. On my end, I expect I will avoid the capital gains tax if the property is flipped in less than a year as my profits will be within the IRA, but he will get hit with tax. Am I understanding this correctly?

5. Is it advisable that the IRA have enough money in it to carry the project through the entire process, or can I use other monies outside of the IRA to fund a portion of the project?

6. Finally, my adult son works for the contractor. Is it okay for him to work on the projects under the contractor's company. I do not plan to give my son any of the profits. He'll reap those benefits when I retire and begin drawing retirement income.

This scenario may not even be possible. That's why I am asking before I devote too much time and energy into this course of action.

Thanks in advance.

[Richard Cohn]

Lots of excellent questions. The answers might require a book. I agree with the other answers - do it through the counsel of a lawyer.

The custodian you are thinking of choosing, or who you do choose, will be the best resource with answers. The 3 custodial companies that have been around for a long time (Pensco, Equity Trust, Entrust) have well trained staff to assist you.

1. It depends on how you structure it - and this can be done a lot of different ways. Will the IRA own the deal, or will you own it as partners with the contractor? If it's a partnership he gets paid at closing.

2. I'm not sure what the question is, but I generally am not in favor of trying to profit based on guessing an area's appreciation rate. I think this becomes speculation.

3. how should he be compensated? Entirely up to what you negotiate. It can be a proportion of the rental income, or a flat fee. This is true of any deal, and not any different for an IRA.

4. Pretty much yes, you are free from tax, but there is a complex school of tax law that says that if your IRA is in the flipping business then you pay a UBIT tax. Not an easy questions. See discussions of "are you a dealer?" throughout BP.

5. Can I use other monies outside of the IRA to fund a portion of the project? Who's money is it you will be using? If it's yours' you have to be careful of self dealing. You can borrow, but only if it is nonrecourse (that's another story). Another alternative is you could bring in another partner.

6. Is it okay my adult son works for the contractor. - Probably a bad idea. You run the risk of being guilty of self dealing. It might not be a problem, but starting out for a self directed IRA I'd recommend something a lot cleaner. Someone else suggested a straight mortgage loan and I think that is a better approach..