Strategies for using a Self-Directed IRA

[Todd Magin]

 

The way I see it, there are basically two ways to use an IRA to finance investments:

1) Have the IRA "buy" the property and ALL income and expenses are paid to/from the IRA. If financing is used in the purchase of the property, the IRA is subject to pay UBIT taxes. It really bothers me that my IRA would have to pay taxes, but perhaps the benefits outweigh this one negative.

2) Have the IRA be a private money lender and finance OTHER people's deals. You can't finance your own deals through your IRA because it would be considered a "prohibited transaction"

a) Form an investor group which lends each other money from their IRAs. If Sally lends Joe money, Joe lends Roger money, and Roger lends Sally money there are no "prohibited transactions". The investor group could either mutually agree on standard loan terms that all abide by or shop for the best terms within the group for each deal.

This is undoubtedly a simplified view on a complicated topic, but am I at least in the ballpark?  Are there some other strategies that I am overlooking?

[Account Closed]

@Todd Magin, Perhaps I can take a bit of the sting out of your point 1. To keep the math easy, an IRA has $100k to invest (leaving a necessary amount for expenses). You find one property for $100k. You can rent it out for $1,200 / month, net ~ 12% for the year. Instead, you find two houses at $100k and buy both using a 50% loan to value non-recourse loan on each. Rent them both out. Doubled your net income and return on investment. However, 1/2 of the funds were not your IRAs money. In this example, your IRA pays unrelated debt finance income tax (UDFI, a subset of UBTI) on 50% of the income, AND is allowed to deduct a ratio of the expenses. If you run the numbers, even after paying an income tax on the portion of income generated using non-qualified money, you are still ahead of the initial 12% total ROI. Making more money using someone else's money. Not a bad deal. Those funds do not become qualified funds just because they are loaned to an IRA, so they do not get the tax deferred treatment. Does this help?