My secret mentor hit me with an honest curveball!

Tax, SDIRAs & Cost Segregation
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My secret mentor hit me with an honest curveball!

Timothy Riley
Investor · Chicago, IL · Member since 2013 · 451 posts · 96 votes

My secret mentor hit me with an honest curveball!

SDIRA Consultants, SDIRA Holders, Real-Estate Tax CPA’s, Attorneys, Chime in:

First - my secret mentor is my attorney which sounds odd seeing that we have two different paths in life.

The reason he is/was my secret mentor is because he’s the first that gave me real honest advice and asked me the first meaningful question that lead me on my path. That advice was “quit playing” and that question was “why are you using your money?”

That wasn’t totally it, this person gave me several pointers on the process of purchases and made every transaction an ease for me and empowering me on who I was with each deal and that this was a business “MY BUSINESS”. He instructed me on getting a team, not just knowing the names of people in the fields that I needed but befriending them. Breaking bread with my Tax CPA (still working on this @Steven Hamilton II LOL), Golfing with my Banker, Watching the game with my contractor…

With all this said I forwarded him some paperwork from my SDIRA to format my LLC to purchase property through that LLC. My original question to him was; my plan is to go with a series LLC is it possible to create a unit (separate llc) within that for the SDIRA to have for the purchases I make for that account or does it have to be a total separate LLC?

His answer was "What's a SDIRA? Speak to a CPA and whatever you do don't let the SDIRA Company create your LLC."

Now shocked that the person I thought knew it all didn’t but thankful for an honest answer rather than being misled, BUT I’m back to square one where all of you come in.

  1. Is purchasing a real-estate in this format a good way to go (not everything just one or two for my later years)?
  2. Can it be done as a unit within my upcoming Series LLC?

One question that I searched but never found the answer to is:

  1. How to cash out when the time comes with the properties in the SDIRA (cash out the balance and take control of the properties, sell the properties within and then cash out)?
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Stan Butler
Investor · Roswell, GA · Member since 2008 · 231 posts · 104 votes
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I am by no means a tax expert, but here is something I have never understood about using IRAs for real estate.

Why would you want to put a tax-preferred asset (real estate) into a tax sheltered account (IRA)? Aren't you losing the tax benefits of the investment all together??

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  • Stan Butler
    Investor · Roswell, GA · Member since 2008 · 231 posts · 104 votes
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    I am by no means a tax expert, but here is something I have never understood about using IRAs for real estate.

    Why would you want to put a tax-preferred asset (real estate) into a tax sheltered account (IRA)? Aren't you losing the tax benefits of the investment all together??

    2Reply
  • Brian EastmanPro Member
    Self Directed IRA & 401k Advisor · Wenatchee, WA · Member since 2014 · 2k+ posts · 2k+ votes
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    @Stan Butler 

    Think of your question differently and it might come to you. Why would you put stocks in an IRA when you can hold real estate instead?

    The tax circumstances between an IRA and personal funds are very different. The goal for the IRA is to invest in the safest possible asset with the potential for solid, consistent returns. Real estate and notes fit that bill nicely.

    @Timothy Riley 

    It sounds as if you are trying to build the LLC yourself. That would likely be a mistake and could result in at best a lot of frustration with a custodian not being willing to accept non-compliant LLC documents or at worse a prohibited transaction if the LLC is not structured properly. There are several professional firms that specialize in this service and provide high quality education (not SDIRA Custodians, but advisory firms). The tool (IRA LLC) is one thing. The knowledge to properly use the tool is the key. As you note, even your sage mentor is in the dark on this specialized topic.

    You could not have an IRA hold a unit of a personal series LLC, if that is what you are asking. In fact, we do not recommend a series LLC in most situations as there is not any sufficient case law to prove the isolation of cells will hold, and in most states there is no cost difference between a series LLC with 2 cells and 2 separate LLC entities.

    There are many exit strategies.  You can continue to hold property and draw off the income, distribute the property in-kind or sell the property and allocate the cash differently - reinvest, distribute partially, etc.  

    1Reply
  • Bill Gulley
    Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
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    I'd say you can, but you'll never see a dime to you until you begin drawing from your plan. You can't manage it an have your lunch paid, so why would you? You can not benefit from the assets held, your plan may. I'm not up on retirement fund management anymore, but it will be hard for you to show that you have no interest in a property, you shouldn't even mess with the management at all.

    As to your LLC question, yes, each unit is held in a cell of a series LLC, each having its own account. :)

    1Reply
  • Timothy Riley
    OP
    Investor · Chicago, IL · Member since 2013 · 451 posts · 96 votes
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    @Stan Butler 

    @Brian Eastman 

    @Bill Gulley 

    I Appreciate your feedback this is all educational. I'm aware that the property would be off limits to me to actually do anything which would lower the cash flow to the IRA . Not liking the lower cash flow but It's a savings mechanism that to my understanding I would save on taxes along with placing money out of reach (reachable but with the way I am a lot less chances of approaching than a regular account).

    By no means would I ever create the LLC myself whichever route I take it would be done professionally. I thought it was odd that my attorney who promotes Series LLC's backed away from SDIRA's holding a unit.

    So I'm taking from your comments that I can have my attorney (whom id rather have) set up my Series LLC (being created for other reasons) and deal with a separate company on the LLC with my SDIRA (it can be done with a unit in my series but recommended not to combine the two).

    Thanks,

    Tim

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  • Loren Whitney
    Investor · North Idaho · Member since 2011 · 332 posts · 107 votes
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    @Timothy Riley 

    I would suggest focusing on the big picture of holding real estate in an IRA before you go looking to understand the complexities of investing IRA funds through an LLC.

    While I can't give you advice, I'd like to paint a quick mental picture and let you make sense of it. For starters, picture your IRA as a separate person other than yourself. Your "IRA" money has already been set aside in an account and withdrawing the funds at this point would mean a taxable event and possibily early withdrawal penalties (10% extra). Since withdrawing the money is typically not very ideal, the alternative is the use the structure that you already have put in place. Consider the tax-advantages associated with your specific account type when choosing which deals work well in an IRA. The next big question becomes, what would you like to invest in and feel confident about?

    Look into leveraging the IRA and using that ordinary deductions to offset UBIT. Many people frown at UBIT and holding real estate in an IRA with leverage but crunch the numbers for yourself and see what makes the most sense. Check out my recent BP blog on common UBIT questions/answers.

    Best of luck to you Tim!

    1Reply
  • Bill Gulley
    Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
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    Originally posted by @Timothy Riley:

    @Stan Butler 

    @Brian Eastman 

    @Bill Gulley 

    I Appreciate your feedback this is all educational. I'm aware that the property would be off limits to me to actually do anything which would lower the cash flow to the IRA . Not liking the lower cash flow but It's a savings mechanism that to my understanding I would save on taxes along with placing money out of reach (reachable but with the way I am a lot less chances of approaching than a regular account).

    By no means would I ever create the LLC myself whichever route I take it would be done professionally. I thought it was odd that my attorney who promotes Series LLC's backed away from SDIRA's holding a unit.

    So I'm taking from your comments that I can have my attorney (whom id rather have) set up my Series LLC (being created for other reasons) and deal with a separate company on the LLC with my SDIRA (it can be done with a unit in my series but recommended not to combine the two).

    Thanks,

    Tim

    I agree, don't comingle the two and follow your attorney's advice. :)

    0Reply
  • Stan Butler
    Investor · Roswell, GA · Member since 2008 · 231 posts · 104 votes
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  • Stan Butler
    Investor · Roswell, GA · Member since 2008 · 231 posts · 104 votes
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    Originally posted by @Brian Eastman:

    @Stan Butler 

    Think of your question differently and it might come to you. Why would you put stocks in an IRA when you can hold real estate instead?

    The tax circumstances between an IRA and personal funds are very different. The goal for the IRA is to invest in the safest possible asset with the potential for solid, consistent returns. Real estate and notes fit that bill nicely.

     Sorry @Brian Eastman, but I still dont see it and here is why:

    * The income from long-term real estate is mostly passive and the expenses associated with owning it are deductible, including depreciation.

    * Selling a long-term real estate holding is subject to the lowest form of taxable income (long-term gains).

    * I can see holding Notes or Option Agreements in the IRA to shield what is most likely going to be active income, which is taxed at high levels.

    * As far as stocks go, I would hold dividend paying stocks and bonds in an IRA to again shield the highly taxed forms of income. But purely growth stocks would be more of a candidate for taxable accounts (since they dont create taxable events themselves)

    2Reply
  • Brian EastmanPro Member
    Self Directed IRA & 401k Advisor · Wenatchee, WA · Member since 2014 · 2k+ posts · 2k+ votes
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    @Stan Butler 

    If you are comfortable that, over the long term, you can get better performance from stocks than real estate, then you should invest in stocks with your IRA.

    Stocks have the potential for rapid growth, but also have no security in the underlying asset.  The bottom can fall out as we see from time to time.

    Real estate will not be as likely to hit a home run, but rather will continue to hit singles.  The SF Giants won the World Series this year without hitting a lot of home runs.

    My point was that comparing the tax implications of real estate inside and outside of an IRA is meaningless. The IRA money has the tax-sheltered status it has, regardless of how it is invested - so just pick the best assets for your IRA. If you have a big enough portfolio to invest in real assets with cash and paper assets in your IRA, that works. Diversification is always a good thing.

    1Reply
  • Timothy Riley
    OP
    Investor · Chicago, IL · Member since 2013 · 451 posts · 96 votes
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    @Stan Butler 

    @Brian Eastman 

    This is exactly the type of feedback I'm looking for. I might want to use the SDIRA for different types of investments.

    If it matters I'm a buy and hold investor who is looking to go full time (leaving my nine to five within five years) but maintain some type of retirement vehicle. The SDIRA has already been opened and lightly funded (recurring scheduled deposits).

    Thanks,

    Tim

    0Reply
  • Account Closed
    Lender · Hot Springs Village, AR · Member since 2014 · 274 posts · 92 votes
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    I started my SDIRA when I was still working. It was mostly hard money lending and became a high yield retirement account. After my retirement the Roth IRA was available. I gradually moved chunks of money from my traditional to the Roth. I used the Roth for another hard money loan and had to foreclose on that property. This has been an incredible source of income as I has been rented for over 7 years although not always to the same person.

    I bought another house to rent when everything was in my traditional IRA. When I reached 70 I took 1/4 of the ownership as my required distribution. I did this for 4 years and now the house is completely out of the IRA.

    I did not use an LLC for either of these deals.

    I suggest that if you need the income stream to use for daily living get it out of the IRA. If you want an excellent savings account keep it in the IRA.

    1Reply
  • Timothy Riley
    OP
    Investor · Chicago, IL · Member since 2013 · 451 posts · 96 votes
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    Thanks,

    @Account Closed 

    That's reassuring on my "planned route" of which lending through the SDIRA is high on the list - I was hoping to use loan repayments and profits to fund the SDIRA holding. I'm only looking to acquire a few units (less than 5) in this scenario.

    I own my home along with three rentals which I will probably triple that amount of properties by the time I can actually fund one through my SDIRA so I'm (fingers crossed) not expecting to need that portion of income for daily living.

    0Reply
  • Dmitriy Fomichenko
    Solo 401k Expert · Anaheim Hills, CA · Member since 2012 · 18k+ posts · 6k+ votes
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    Originally posted by @Stan Butler:
    Originally posted by @Brian Eastman:

    Think of your question differently and it might come to you. Why would you put stocks in an IRA when you can hold real estate instead?

    The tax circumstances between an IRA and personal funds are very different. The goal for the IRA is to invest in the safest possible asset with the potential for solid, consistent returns. Real estate and notes fit that bill nicely.

    Sorry @Brian Eastman, but I still don't see it and here is why:

    * The income from long-term real estate is mostly passive and the expenses associated with owning it are deductible, including depreciation.

    * Selling a long-term real estate holding is subject to the lowest form of taxable income (long-term gains).

    * I can see holding Notes or Option Agreements in the IRA to shield what is most likely going to be active income, which is taxed at high levels.

    * As far as stocks go, I would hold dividend paying stocks and bonds in an IRA to again shield the highly taxed forms of income. But purely growth stocks would be more of a candidate for taxable accounts (since they don't create taxable events themselves)

    Generally, I believe that buying real estate in your own name and get the tax deductions would be better choice IF you have that choice. This way you can take advantage of the lower tax rates of capital gains and being able to use tax benefits such as depreciation deduction now. And then use retirement funds to purchase other passive income producing assets such as trust deeds and shelter that income from taxation. 

    However, for most people that is NOT the case. Let me give you an example: 

    Last year I had the opportunity to purchase investment property in AZ. This property was not on the market, it was a good deal and had great potential. I did not have the cash to buy this property in my name, but I had cash available in my retirement account. So my choice was either:

    • Pass on this deal completely because I was not able to acquire this in my name and use cash in my retirement account to invest in stocks. or
    • Buy this property in my retirement account.

    If I was to use your analogy I should have passed on this investment. 

    But I didn't - I purchased it in my retirement account, got it fixed and rented. I used leverage to acquire it. If I were to sell it now I would have doubled my money (because of leverage). 

    There is no way I could do that investing in stocks, my risk would be much higher and I would not have any control over my investments (we can't control the stock market). 

    So to piggyback on comment of Brian above, if you have money in your IRA or 401k - you need to invest it wisely. Which investment would be less risky and give you highest return - that is the choice you need to make. And the question is NOT - should you buy it inside or outside of your IRA - for most people in most cases this question is meaningless.

    1Reply
  • Steven Hamilton IIPro Member
    Accountant, Enrolled Agent · Grayslake, IL · Member since 2011 · 5k+ posts · 2k+ votes
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    I understand wanting the series LLC; however, do not use one cell for an SDIRA and one for personal. That is a distinct violation as you and the LLC are benefiting.

    [email protected]224-381-2660
    1Reply
  • Dave Toelkes
    Investor · Pawleys Island, SC · Member since 2008 · 1k+ posts · 837 votes
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    Originally posted by @Timothy Riley:

    I was hoping to use loan repayments and profits to fund the SDIRA holding. I'm only looking to acquire a few units (less than 5) in this scenario..

    Loan repayments? Is your plan to take a loan from the IRA to fund the real estate purchase?

    0Reply
  • Brian EastmanPro Member
    Self Directed IRA & 401k Advisor · Wenatchee, WA · Member since 2014 · 2k+ posts · 2k+ votes
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    @Timothy Riley 

    It is pretty clear from this thread that you are not in full understanding of how a self directed IRA fits into the equation of investing in real estate. Getting it wrong can be very, very expensive. That said, with proper education, it is very easy to operate a SDIRA within the rules and grow your savings quite nicely in real estate.

    Rather than rely on bits and pieces of information (some of which comes from those outside the field), I would strongly encourage you to contact a firm that specializes in implementing and supporting the IRA LLC platform.

    1Reply
  • Rob K.
    Encinitas, CA · Member since 2011 · 192 posts · 252 votes
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    @Stan Butler 

    I think you ask very good questions. When comparing the tax advantages one gets when investing individually vs. a SDIRA where you get depreciation, etc., many times purchasing via a SDIRA is not nearly as advantageous as outside an IRA, especially given the additional prohibitions on obtaining personal benefit and hassle of extra administrative layer.

    And this is particularly true for traditional SDIRAs where taxes are deferred and everything will eventually come back at ordinary tax rates, not capital gains rates.

    But a ROTH SDIRA is a completely different analysis. I converted a defined benefit pension plan to a  ROTH SDIRA in 2010. Paid the conversion tax (there was a special rule then that allowed me to spread the conversion tax over two years) and bought a rental property at a great deal. With a ROTH SDIRA,  appreciation in the property and accumulatted net rental income for the life of the ROTH SDIRA come out tax free. Depreciation deduction? Naw, I don't miss that at all.

    I can't imagine ever wanting to touch a series LLC within an IRA. With custodians that allow "bill pay", and a property manager in place, I personally don't see the need to complicate one's life at all with an LLC within an SDRIA.

    1Reply
  • Lumi Ispas
    Real Estate Consultant · Chicago, IL · Member since 2014 · 720 posts · 439 votes
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    Hi @Timothy Riley,

    Who do you have your SDIRA with? The company that I have mine with is amazing, as the money they holds is used mostly for purchasing Real Estate or financing RE deals.  They are a local company, here in Chicago. Let me know if you want their info.

    They will give you directly any advice you want and their fees are minimal.

    1Reply
  • Crystal SmithPro Member
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    Real Estate Broker · Chicago, IL · Member since 2014 · 2k+ posts · 1k+ votes
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    @Timothy Riley 1st let me say I'm not an accountant or CPA or lawyer, I just play the part on Tv.  We've been investing w/ SDIRA's for a long time.  So here's my response to your questions:

    • Is purchasing a real-estate in this format a good way to go (not everything just one or two for my later years)?  Best decision you can make is purchasing as much as possible in the SDIRA & minimizing/eliminating the tax burdens
    • Can it be done as a unit within my upcoming Series LLC?- Danger, Danger, Danger; You treading on thin ice. There's a way to have a Joint Venture between your LLC and the SDIRA but you need a lawyer that specializes in this to walk you thru the traps. Not sure why you would need an LLC if your using the SDIRA unless of course what you mean is your going to establish a check book IRA where the LLC is the custodian & your intent is to have multiple checkbook IRAs w/ the LLC as the custodian. There's a company in Seattle, who's name escapes me now, that is excellent @ this.
    • One question that I searched but never found the answer to is: How to cash out when the time comes with the properties in the SDIRA (cash out the balance and take control of the properties, sell the properties within and then cash out)? You really can't cash out without a huge tax hit before you reach the so called retirement age. You may want to look into non-conforming loans as a mechanism to cash out. I don't know all the details but it's usually a 50% LTV requirement & your account must have enough funds in it to service the loan.
    312-681-7487
    1Reply
  • Account Closed
    Investor · Kirkland, WA · Member since 2014 · 101 posts · 56 votes
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    Crystal Smith I'm considering the same type if investment at the moment and am in the Seattle area...if you remember the name if that company let me know! Thx!
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  • Crystal SmithPro Member
    Moderator
    Real Estate Broker · Chicago, IL · Member since 2014 · 2k+ posts · 1k+ votes
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    @Account Closed The name of the company is Guidant Financial Group LLC.

    312-681-7487
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  • Steve Vaughan
    Rental Property Investor · East Wenatchee, WA · Member since 2014 · 10k+ posts · 16k+ votes
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    If I were to use an SDIRA for RE I would use it for my fix and flips only. Long-term holds have too many inherent tax advantages. You will also forever be paying every little expense from and accounting for every rent check inside this separate SDIRA acct. If this is held within a bunch of complicated series LLC cells and whatnot I think it will bite you. SDIRA property is titled "Servicing Agent FBO your name." I imagine the bank acct is as well. Flip the property, shelter the profits, move on. BTW, is this a Roth or traditional IRA?

    1Reply
  • Mark Whittlesey
    Real Estate Investor · Encinitas, CA · Member since 2013 · 225 posts · 91 votes
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    @Stan Butler  I don't put rental real estate into my SDIRA. I put real etate notes or rehab properties that I intend to re-sell (ie flips).

    1Reply
  • Account Closed
    Investor · Kirkland, WA · Member since 2014 · 101 posts · 56 votes
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    Crystal Smith thanks! Timothy Riley my CPA advised me to use a SDIRA to buy and hold, so I have a lot of the same questions (and I'm inclined to agree with a lot of folks here - doesn't seen like that's the best strategy). Since the end of the year is nuts I won't be talking about it in detail with him until January, but if I learn anything (that's not already mentioned here) I'll let you know. Good luck!
    1Reply
  • Daniel DietzPro Member
    Rental Property Investor · Reedsburg, WI · Member since 2011 · 1k+ posts · 857 votes
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    Good conversation going here with a lot of good points, but I am going to be contrary to what seems to be the 'popular opinion' :)

    I do have a buy-n-hold in a SDIRA, that is in a three-way LLC with my brother and father, and we intend to add more to our portfolio..... yes, this would normally be a no-no, but we were VERY careful about setting it up with professional advice.

    Why did we do it this way? 1) Our IRA's are where we all hold the vast majority of our invest-able assets, probably 90-95%+, so that is 'where the money is' so to speak. 2) With what we are investing for at this time, we are looking for long term gains to use upon retirement..... a long time down the road so immediate use of cash flow is of no concern. 3) I am planning/hoping to use leverage in the near future, BUT from what I have been able to learn so far, the UBIT should not be too much of an issue. My understanding on this is IF you are using leverage, you can (must) also figure depreciation. Just as with many rentals OUTSIDE of SDIRAs, after figuring the depreciation, there is not much 'taxable profit' left, so not much UBIT either.

    There is also a great comment earlier in this thread I believe point out not to think of 'where to hold my real estate' but rather 'what is the best investment (of ANY kind) that my IRA can make?'. My estimates show that we could achieve about a 16-18% returns long range with NOT being leveraged at all. Can I do that with stocks? Not sure, but not as likely long term with as little risk I would bet.

    A great link for those who missed it about UBIT is here

    http://www.biggerpockets.com/blogs/5105/blog_posts...

    Dan Dietz

    [email protected]608-524-4899
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