Parents Self Directed IRA, any investment options?

Question

My Father has a 401k that he isn't using for income at all.  Next year he will have to start taking minimum distributions from it.

I'm interested in acquiring real estate using the BRRRR strategy.  Is there any way to leverage his unused 401k account by transferring it to a self directed account to help with real estate financing?

I've tried doing a few google searches and see some things that aren't allowed.  Was just wondering if there were any creative ways that would allow my Father to help with financing, which I would pay interest on.  Thanks for any feedback!

Dmitriy Fomichenko · Answer

Joel, your father certainly can setup a self-directed IRA for real estate investing. But as far as partnering with you on a deal - that won't work. You are considered to be a "disqualified person" to his IRA. The IRS rules prohibit an IRA to engage in any transaction with disqualified person.

Dmitriy Fomichenko · Answer

Yes @Jessica Zolotorofe, as long as all the rules are followed it should be fine, but you know when it is father/son type of situation the temptation is there to bend the rules specially when the pressure is on, hence my recommendation.

Linda Weygant · Answer

If there is one thing that the IRS hates, it is "creativity" with regard to their rules.  The rules on this are lengthy and have been tried and tested in the courts.  This money is designed by law and with specific intent to be off limits to you.  You are best advised to take your eye off of this money as a resource for your plans and look elsewhere.

Dmitriy Fomichenko · Answer

@Jessica Zolotorofe,

Yes it is possible to co-invest in the same LLC with a disqualified person. However, I do not believe that is what Joel was looking to do, he wanted his father's IRA finance his real estate investment acquisition.

Also, I've seen transactions that were allowed in the beginning but because of the disqualified person involvement lead to a prohibited transaction down the road. Like I said there are many ways to make money without taking such risk therefore my recommendation is to stay away from any transaction involving disqualified person.

Bernard Reisz · Answer

@Jessica Zolotorofe Appreciate the mention and bringing my attention to this forum. And, as always, you've provided great info.

@Joel S. There may be some ways in which your father's retirement funds can be leveraged, some of which have been suggested on this forum. Regarding coinvesting with your father's retirement account, it is certainly acceptable - in theory - in many circumstances. In practice, it does come with along with some additional complexity.

There are many strategies that are suggested to circumvent the prohibited transaction rules, which when subjected to deeper legal scrutiny are not viable. Likewise, there are legally viable strategies that are rejected, which are in fact acceptable. Good counsel will help you navigate the rules, enabling you to take advantage of legally acceptable work-arounds and steering clear of dubious approaches.

Jessica Zolotorofe · Answer

Mat Sorensen is considered one of the top experts in the field. He wrote the SDIRA Handbook and is an attorney specializing in this type of investment. He specifically says  on page 204 of the Handbook "Multiple IRAs of disqualified parties may co-invest and own shares of an IRA/LLC at the time of formation and initial ownership allocation". IRS Advisory Opinion #2002128011 supports that proposition.

On Page 206 he indicates that the same structure is permissible with an IRA and an individual cash investor (whether they would otherwise be disqualified or non-disqualified) as long as any future contributions are pro rata to their initial investments and neither buys additional interests. Take a look at DOL Advisory Opinion 2000-10A.

On Page 212 in Sorensen's Q&A section he says "Is the company a newly formed company? If so, disqualified persons may co-invest".

Again, I've spoken to many lawyers and specialists, all who concur with the foregoing. I am well aware of the risk involved in taking the advice of a custodian without double checking, and would suggest everyone check with their accountant and lawyer, but while you think the law is "pretty clear", I agree that it is clear, but not in support of what you are saying it is. Like I said, there is an exception to the rule.

Dmitriy Fomichenko · Answer

Jessica, IRS rules are pretty clear, all transactions involving an IRA must be 'arms length":

https://www.irs.gov/retirement-plans/plan-particip...

If you've seen something done that doesn't make it right. And many so called "experts" including IRA custodians don't fully understand the rules. Consulting thousands of clients I've seen few who have been given a "green light" by the custodian for a transaction that was clearly prohibited. And guess what: the custodian is off the hook, it is the account holder who totally responsible (just read the account application with any custodian and you will see that they wave all the liability).

There are some transactions that are clearly prohibited, others are clearly allowed, also there are some that are in the "grey area". The advice I give to my clients is to stay away from such transactions. Do you really want to take a chance with the IRS and risk your entire IRA? There are so many ways to make good returns on your money legally so in my opinion it is simply not worth it to engage your IRA in any transaction with disqualified person.

J Scott · Answer

Can you expound on what the exception is?

Jessica Zolotorofe · Answer

@Dmitriy Fomichenko If they partner from the beginning, isn't there an exception? They can't later join forces, but I thought if it is the plan from the beginning they actually can invest together? Is that exception just for spouses?

George Blower · Answer

@Joel S.

If he plan's to perform some part-time self-employment income and continues to do so, he can transfer the 401k if it is from a former employer or if he is over age 59/12 to a self-directed solo 401k. The solo 401k can then obtain non-recourse financing or investing in real estate. For a list of non-recourse loan lenders, click here.

One of the advantages of a solo 401k over an IRA is that unrelated debt financed income tax (UDFI) does not apply to solo 401k plans but does to IRAs.

Parents Self Directed IRA, any investment options?

Most Popular Reply