Can you use a 401k or IRA and keep cash flow now?

Question

Doreen Chaisson · Answer

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).

Margie Pierce · Answer

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?

Rajeev Kotyan · Answer

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.

Brian Eastman · Answer

Mark C.

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.

Adam Adams · Answer

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

Mark Nolan · Answer

@John Hyatt

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.

Andrew Portnoy · Answer

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.

David Faulkner · Answer

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. · Answer

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?

Can you use a 401k or IRA and keep cash flow now?

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