Another SDIRA SD 401k question

[Thomas Dowell]

I'm a new member here on the forum and have a couple questions about SDIRAs and SD-401ks. I'm just starting my career as an active duty military member but I also independent contractor work as a flight instructor so I'm not sure if I qualify for a solo 401k or not? I've got approximately 15k in my Roth, and as I understand it I can use that as a down payment and get a mortgage on a buy and hold property? I'm very much oriented towards long term wealth growth and cash flow as passively as reasonably possible. I've had a mentor suggest liquidating my Roth IRA to buy a rental, but I don't see why I would do that if I can just buy and hold under the tax shelter. So I guess I'm just seeking some general advice on where to start, and if starting with an SD Roth is a good idea or not. Thanks!

[Doreen Chaisson]

If you have any 1099 income, you can have a Solo(k), which has higher contribution limits than a Self-Directed Roth IRA does. However, keep in mind that any salary deferral must be from THAT income source - you would not, for example, be able to put any money earned from your military service into your Solo(k).

With either type of account, the IRS permits you to buy and hold Real Estate as long as it is not property you or any of your disqualified parties (parents, spouse, children, children's spouses) currently own, have ever owned, or currently live in. It has to be strictly for investment purposes. Any income generated flows back to the retirement account, and any expenses or repairs, including insurance, property taxes, painting, mowing and so on, must be paid for with retirement funds. The IRA owner and any disqualified parties are prohibited from doing any work on the property themselves (sweat equity) as this is considered improving an IRA asset with non-IRA funds and is an illegal contribution. Outside vendors/contractors/property managers who are willing to bill the IRA directly must be used.

However, you mention you only have about $15k in your current Roth, which you could transfer to a Self-Directed Roth account with a special asset custodian for purposes of Real Estate investing. You would not be allowed, per IRS regulations, to use that IRA money, within the IRA account, and personally take out a mortgage for the balance of the purchase as it is a prohibited transaction to use an IRA asset as collateral for a personal loan.

The good news is that your IRA/Solo(k) CAN take out its own mortgage in the form on a non-recourse loan. In this scenario, the IRA puts a down payment and has a mortgage on the balance. Each month, the IRA/Solo(k) makes the mortgage payment. Non-Recourse lenders willing to lend to retirement accounts have varying requirements on both the amount of down payment they require (typically about 30%), the terms and length (generally 3 - 5 year ARMs) and they type of property they will lend on (generally NOT raw land or mobile homes).

Leveraging a Real Estate purchase inside an IRA will result in a tax called UBIT -Unrelated Business Income Tax. This means a percentage of the income generated by the property will be subject to taxation (paid by the IRA). This percentage is roughly equal to the percentage of the purchase that is financed. So if the IRA put down 60% and financed 40%, roughly 40% of the net income generated would be subject to this tax. As the mortgage loan is paid down, the amount of income subject to UBIT decreases accordingly.

Solo(k)s are not subject to UBIT on leveraged Real Estate.

It's always best to call a qualified Solo(k)/IRA Custodian to talk through your particular investment scenario. They will alert you of any possible prohibited transactions you need to be aware of.