Can't seem to figure this out...

[Ryan Sanders]

I have begun my investing journey and was lucky enough to stumble across my neighbor, who has access to close to $250k in a 401k from a previous employer which he has not moved yet. As such, he is eligible to move it into a self-directed IRA and I have suggested he do that so we can invest in real estate together with this. Reading more about self-directed IRAs, I now have some questions that I can't seem to find answers to.

1) I am the 'primary' investor and I own the LLCs used to purchase the real estate and his IRA would merely provide funding to the LLC through a partnership agreement between us. Can his IRA do this without the IRA being listed as the owner of the property, and can he keep any profits or do they have to roll back into his IRA? Also, are my share of the profits affected in any way? This then leads to another question:

2) Can I invest some of my free-and-clear (non retirement account) income in these deals and use his IRA for the rest?

3) As many on here will attest, leverage is very powerful, and just because I've gotten lucky access to a large fund of cash, I would still like to leverage properties to maximize my growth and return. Can we still leverage deals using the IRA for down payment?

4) Lastly, If my LLC purchases a rental property using solely my neighbor's IRA funds and I rent the property, is my LLC allowed to contribute to maintenance of the property at all, or does all money for the property have to come from the IRA?

Thank you for any assistance,

Ryan

[Brian Eastman]

@Ryan Sanders

Your neighbor can either partner with your LLC or lend to your LLC using a SDIRA. How you wish to structure your relationship will affect entity structuring, vesting of title to property, and how the income to your neighbor's IRA may be treated.

If he is using IRA funds, he needs to avoid mixing in his own non-IRA funds. All proceeds that flow to his side of a deal must go to the IRA. He cannot take income from the IRA investments, though if he is over age 59 1/2, he can take taxable distributions from the IRA at any time.

Because you are not a disqualified party to your neighbor's IRA, his IRA and you (or your LLC entity) can structure deals in many different ways. He can provide all the capital or some of the capital. Capital can be lent or can represent equity in the property. His IRA and your LLC can joint venture, or his IRA can take an equity stake in your LLC. You will want to work with a good real estate attorney to see what will work best both at protecting your mutual and individual interests, but also from a tax reporting perspective.

There does not necessarily need to be a direct relationship between the percentage of capital provided and the percentage of equity in a deal. He could provide 80% of the capital and you could provide 20% of the capital plus all of the operational services, and you could then take a larger than 20% cut of the profits. The IRS is OK with any of that, so long as he does not transact with a disqualified party to his IRA.

If he has equity in a deal, and the deal uses debt financing, then the IRA will be subject to UDFI taxation. Any debt instrument will need to be non-recourse, at least with respect to his IRA. He cannot pledge a personal guarantee. Something you will want to study up on. Not a deal killer, but something to understand.