Need help understanding a self-directed IRA

[Drew Castleberry]

So I've scoured BP and the web on self-directed IRAs and have gotten a bunch of useful information. Unfortunately the information I was able to find was mostly on setting one up and general guidelines on how to operate one, mostly within the rules of the IRS.

Here's my situation - In January I'm moving to a different group within my company, and unfortunately I won't be able to keep my current 401k, the new group offers a different one. So I have the option of rolling it into my new one (which isn't very good), or doing something else with it. What I want to do is roll it into a self directed IRA so I can purchase real estate with it.

But here's the kicker, I don't have enough in to 401k to purchase cash for any properties. I currently have about $35k in it, which would be more than enough to purchase a couple town homes by the local college that will produce good returns, and that's my plan for using the money.

However, what I don't know is can you obtain a mortgage through a SD IRA? And how would the logistics of making all the mortgage payments, maintenance fees and other costs work? I certainly wouldn't want to have to pay fees to a company handling the IRA to make those transactions.

Can anyone clarify any of this for me?

[Brian Eastman]

@Drew Castleberry

IRS rules allow an IRA or 401(k) to borrow, but the terms of the loan must be non-recourse. This means you or a disqualified party to your plan are not allowed to pledge a personal guarantee, and the lender's only security will be the property.

Lenders:

The leading lenders who offer such non-recourse loans at the national level include:

First Western Federal Savings Bank

www.myiralender.com

North American Savings Bank

www.iralending.com

You may be able to find a local or regional bank willing to lend on a non-recourse basis. Typically, large national banks do not offer such loans for single family residential property.

The problem I see with your scenario is that most lenders want to lend a minimum of $50K with about 35-40% down and 10-15% in reserves.  Your numbers won't likely fit in that profile, so you may need to look at private lenders instead.

Tax Implications for IRA Borrowers:

When an IRA uses debt-financing such as a mortgage to acquire property, the portion of the income derived from the borrowed capital is taxed as Unrelated Debt Financed Income (UDFI).

Generally speaking, the impact of this tax on your returns is minimal, and you are going to receive a higher cash-on-cash return using leverage, but you certainly want to be aware of the burden of this taxation going in.

If you establish a self directed IRA with a custodian (Trust Company), you will need to submit requests for all expense payments - including the mortgage - and pay processing and/or asset based fees depending on the institution.

If you establish a checkbook IRA LLC, then you control the checkbook and do not require 3rd party processing. You'll likely pay more up front to establish this structure, but save money over the long term and have a more effective tool to work with that provides asset protection.