Can you use a 401k or IRA and keep cash flow now?
Investor · Glendale, AZ · Member since 2015 · 113 posts · 47 votes
Brian is correct in that if your IRA funds a RE purchase, you cannot funnel any of the proceeds to yourself personally.
However, if you co-invest personal funds with your IRA funds as tenants-in-common, you are entitled to your share of the income, based on your percentage of personal ownership. You can never take more than your share of profit; similarly, you can't have your IRA receiving more than it is due - it could be considered an illegal contribution to your IRA. Keep in mind, in a tenants-in-common situation, you will also be personally responsible for your share of expenses, taxes & insurance, based on personal ownership percentage.
If your IRA invests in a property with other people as tenants-in-common (whether with their personal funds or their IRA funds), it's the same - income and expenses are split based on percentage of ownership.
Check with a knowledgeable professional to be sure you're not running afoul of any prohibited transactions such as enabling (using IRA funds to enable a personal investment).
The answer is no.
The principle of a self directed IRA or 401k is no different than any other retirement plan, just because it can be invested differently. The IRA is tax-sheltered because it is not for your current use. When you wish to access the funds (generally after age 59 1/2), you will pay taxes on the amount you distribute to yourself.
While in an IRA or 401k, there can be no direct or indirect benefit between the plan and a disqualified party.
A self directed IRA is not about creating now income, it is about diversifying your savings for your future retirement. Simple as that.
If you are funneling funds from a plan funded transaction into an arrangement elsewhere that benefits you, that would be in violation of the IRS rules and could result in very severe tax consequences for your plan. Not wort messing with.
Brian is correct in that if your IRA funds a RE purchase, you cannot funnel any of the proceeds to yourself personally.
However, if you co-invest personal funds with your IRA funds as tenants-in-common, you are entitled to your share of the income, based on your percentage of personal ownership. You can never take more than your share of profit; similarly, you can't have your IRA receiving more than it is due - it could be considered an illegal contribution to your IRA. Keep in mind, in a tenants-in-common situation, you will also be personally responsible for your share of expenses, taxes & insurance, based on personal ownership percentage.
If your IRA invests in a property with other people as tenants-in-common (whether with their personal funds or their IRA funds), it's the same - income and expenses are split based on percentage of ownership.
Check with a knowledgeable professional to be sure you're not running afoul of any prohibited transactions such as enabling (using IRA funds to enable a personal investment).
Is it true that between you and your IRA, together you cannot own more than 49% of the investment? In other words, you can't "control" the investment if you're in partnership with your IRA?
No, that is not the case.
What you could not do is invest an IRA into something that you or disqualified parties already control. In forming a new entity/venture, it is OK for the IRA and a disqualified party to have up to 100% combined equity.
Such joint venture transactions are often promoted loosely on the internet, including here on BP. I would note that extreme caution and the assistance of a qualified CPA or Tax Attorney familiar with ERISA law is critical for such ventures.
The IRS does not provide specific guidance on your ability to JV with your IRA, for example. The general interpretation is that an IRA and a disqualified party may joint venture under the conditions that:
The consideration not often mentioned, however, is that there can be no direct or indirect benefit between an IRA and a disqualified party, and this is where a lot of folks could get in trouble. A benefit would be the ability for either party simply to engage in the transaction, if they could not otherwise do so without access to the funds of the other party.
So, if your IRA could purchase a property - perhaps with the use of a non-recourse loan - and you elect to JV with yourself or another disqualified family member, that is not likely a problem. But, if the IRA simply could not do the deal without access to those personal funds, then you have enabled the IRA and that could be viewed by the IRS as a benefits. The same would be true in reverse, if the IRA is enabling you.
An investor engaging in this kind of joint venture is definitely getting into a gray area where the regulations are not clearly defined, and that creates risk.
Thank you SO much @Brian Eastman - I generally understand SDIRAs very well. I utilize a SD 401k, my partner utilizes a SDIRA and I have several clients that have these types of accounts as well. I kept running into conflicting information when I was looking to purchase the most recent property. Since I couldn't sort through all the conflicting information out there, we just elected to stay out of partnership with our SD accounts in order to be safe.
I'm glad we did because we were definitely in the position where we couldn't purchase without the assistance (in both directions), so we elected to bring third parties into the purchase instead.
... 50 shades of SDIRA gray ...
So if i enter into a JV with my SDIRA, and can show that the SDIRA could buy the property on it's own via a non-recourse loan, and that I could also have bought the property with a regular mortgage, then it would seem I have no direct nor indirect benefit, correct?
If that works with a cash deal, can I throw a mortgage into the mix?
e.g. $200k purchase, $50k comes from SDIRA as cash with proof that SDIRA could have got a non-recourse loan. $150k comes from me personally in the form of a mortgage, with proof that I could have also bought the property with say $10k down, and the rest as a mortgage. The split would start with me having 75%, and SDIRA at 25%, and that would not change. Is this a valid shade of gray for the IRS?
There is no absolute answer to this question. The IRS would, if they chose to look at this, make their own determination as to whether there was a benefit resulting in self-dealing. The law does not outline such specifics and there is little case law to rely on.
We would definitely not recommend that you JV with your IRA while obtaining debt-financing personally. Your personal guarantee of that debt instrument in a transaction where the IRA has involvement would be very risky.
Our firm's approach to such JV transactions is one of caution. We do not in any of our literature or consultations with clients promote such transactions. If a client comes to us wishing to engage in such a transaction, we will be very clear about the risks and leave it to the client to discuss with their legal counsel.
So in Colorado you have to have a RE license to be paid to mange a property for someone else. So if you have a property in your SDIRA/401k you can't just get your buddy to manage it, unless he happens to have an RE license.
My understanding is that if you get someone to partner with your SDIRA/401k, they are a managing partner of the JV, and do not need a license.
So this leads me to the optimal SDIRA/401k cocktail ...
1) Say 20% in cash from your SDIRA/401k, with proof that it could have bought the property on it's own with a non-recourse loan.
2) say 75% from you as a mortgage, with proof that you could also have bought the property another way.
3) 5% from a non-disqualified party who will act as a property manager without a real estate license. Perhaps you can do a complimentary deal with their SDIRA/401k and you acting as manager.
Will this pass IRS scrutiny?
Is anyone doing this?
If you fund the investment with a Roth IRA that you have owned for 5 years or more you could take distributions in the form of cash flow up to your principal amount without penalty. Not sure that you should, but you could ... personally, I'd rather leave it in there to compound tax free for as long as I could.
@Mark C.: From what you appear to be stating is that the IRA will buy the property (20% monies down) and you would be providing a mortgage (75% monies) and the balance is from a third party. If that is correct in my understanding then you are effectively lending monies to your IRA, which is prohibited.
If on the other hand you are stating that you are creating a JV (20% IRA, 75% personal and 5% third-party), and your portion is a personal guarantee pledge of ownership to borrow the monies to pay for your share, then you are extremely close to stating that you are using your IRA based partnership to enable you to get a loan which is a prohibited transaction.
While these appear to be good food for thought, as professionals we would be happy have you test the case with the IRS so that we can all learn from your experiences (I am sure Brian would concur too) :-). This is a not a recommendation that we would provide.
I went to a presentation by a self directed IRA company and had exactly some of the same questions that you have here. As it was explained to me, you and your IRA can absolutely co-invest in a rental property. The key thing is that you need to be investing on equal terms from a cash/equity/debt perspective. However you split the down payment is exactly how much ownership each party has in the deal, including all income, expenses and profit.
You are essentially purchasing the property with a new entity owned by both you and your Ira. You and your Ira must fund this new entity and split all costs in accordance with your respective ownership percentage.
My understanding is there would be no way to personally guarantee a loan or have your Ira guarantee a loan for its portion of the JV because that would be viewed as a contribution or distribution, respectively.
Strictly speaking you would also be prohibited from improving the property yourself because that would be considered a contribution to the property. You are allowed to act as an agent of your Ira (eg arranging for a contractor to perform work), but doing the work yourself will jeopardize the tax benefits of your ira's portion of the asset.
Regarding example 1 yes you can accomplish such a transaction under a tenancy-in-common (TIC) arrangement. The 50% would flow back to the solo 401k and other 50% to you and you would pay capital gain taxes on your 50%. Special rules apply when investing in real estate alongside your own solo 401k though which I have discussed in may other posts already.
Yes you can keep it... ...inside the retirement account (probably not what you wanted to hear). Prior to the age of retirement, you would NOT be able to take the passive income out of your retirement account to live off of without tax consequences.
(With that said, I believe you may be able to take care of your example 1 and 3 if everything is set up correctly ahead of time.)
Make sure you speak to professionals (Real Estate Attorney, CPA, CFP, and those already using a QRP for the reasons you are looking into) that are in your area before you do anything like this. You would need a qualified 401K "solo-K" set up first. If you were in Colorado I would have some good referrals for you. There are things called prohibited transactions, 4 quick examples of prohibited transactions are
1) paying yourself a wage for managing your property,
2) putting sweat equity into the investment owned by your retirement account,
3) using the residence as a vacation for yourself, your parents, or your kids (even once),
4) purchasing a property from yourself to put it into your retirement account.
Prohibited transactions can result in very severe tax consequences, so you'll want to be sure you understand them all, prior to investing with a retirement account.
P.S. If it wasn't clear before, not all retirement accounts are created equally, they are all structured differently so you'll want to make sure of what your specific account can and cannot do. Make sure you get a Qualified retirement account set up, correctly, and get continued support from your attorney, planner and CPA.
Good luck!
Adam
What if I purchased a property using a 50/50 non-recourse mortgage where in I put down $150,000 and borrowed $150,000 and then let’s say I generated $1000 per month cash flow and withdrew it out of the account on a monthly basis knowing I would effectively only receive $500 per month because it would be taxed at a higher rate with a 10% penalty?