Can I invest a $60k roll over IRA in real estate?

Question

I have had a rolled over IRA invested in mutual funds for the last 10 years and am interested in diversifying my portfolio with real estate. There is roughly $60k in the account. Is this possible without penalty?

Odie Ayaga · Answer

Wow @Aaron Quinn congratulations you managed to get like every BP expert on SDIRA's to respond and even chief expert on all things @Jay Hinrichs. A lot of incredible info above from all parties. Based on the conversation and your confusion trying to follow it (completely understandable) I would recommend giving a listen to BP Podcast Episode 211 with the note professor himself @Bob Malecki. He talks about what they were getting into above with UDFI and how he used his SDIRA and a lot of other related topics that will probably be of interest to you based on your questions.

Dmitriy Fomichenko · Answer

Aaron,paying the penalty plus taxes does not seem to be like a wise move if you can invest your money using self-directed IRA into alternative assets and shelter income/gains from taxes. Retirement accounts are designed to be invested passively so you gotta be careful with the flips (holding property for short term) in your IRA, if you start doing that on regular basis it might be considered that you running an active trade or business in your IRA and that will result in UBIT.

Brian Eastman · Answer

@Jay Hinrichs @Gail Greenberg is actually referring to UDFI (Unrelated Debt -Financed Income) which is a subset of UBIT that applies to leveraged IRA investments. For most investors, the impact of this tax is negligible and represents a very small tax cost for being able to use leverage inside of an IRA and generate a higher cash-on-cash return as a result. To classify this as a "costly tax" is a significant overstatement. The deal with leverage in an IRA is to do the math, not shut the concept down because the word "tax" comes into the discussion. I will gladly pay an extra $600 in taxation and CPA filings to make an additional $4,000 thanks to the use of leverage.

Gail Greenberg · Answer

Yes @Aaron Quinn the vast majority of my JV investors in distressed notes are using self-directed IRAs or 401Ks. It's great because of the favorable tax treatment - you can build a big note portfolio by reinvesting income as your notes pay off or you sell them. $60,000 would not be enough to buy and renovate a flip and probably not enough to buy a rental outright. You can use your $60K as a downpayment on a rental and finance the rest with a non-recourse loan, but then all your profits will be subject to UBIT, which is a costly tax that eats into your return. On the other hand, when I was new in note investing, I had a property I owned the 1st lien on burn down after just 9 weeks. I invested $15,000 and got a complete payoff of my balance of $42,000 and it was in my Roth IRA so no taxes ever! That's my kind of real estate investing! And the borrower whose house burned was actually thrilled with the outcome too because she got enough to buy a new house outright. She'll never have to make another mortgage payment.

George Blower · Answer

@Aaron QuinnThe following site further confirms that an IRA may be invested in real estate.The key is to use the services or an IRA custodian that will service a self-directed IRA. https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-iras-investmentsAnother option is the solo 401k if you are self-employed. Only part-time self-employment is required and it can be performed on the side if you have a full-time job already. Following are the similarities and differences between the solo 401k and the self-directed IRA.The Self-Directed IRA and Solo 401k SimilaritiesBoth were created by congress for individuals to save for retirement;Both may be invested in alternative investments such as real estate, precious metals tax liens, promissory notes, private company shares, and stocks and mutual funds, to name a few;Both allow for Roth contributions;Both are subject to prohibited transaction rules;Both are subject to federal taxes at time of distribution;Both allow for checkbook control for placing alternative investments;Both may be invested in annuities;Both are protected from creditors;Both allow for nondeductible contributions; andBoth are prohibited from investing in assets listed under I.R.C. 408(m)The Self-Directed IRA and Solo 401k DifferencesIn order to open a solo 401k, self-employment, whether on a part-time or full-time basis, is required;To open a self-directed IRA, self-employment income is not required;In order to gain IRA checkbook control over the self-directed IRA funds, a limited liability company (IRA LLC) must be utilized;The solo 401k allows for checkbook control from the onset;The solo 401k allows for personal loan known as a solo 401k loan;It is prohibited to borrow from your IRA;The Solo 401k may be invested in life insurance;The self-directed IRA may not be invested in life insurance;The solo 401k allow for high contribution amounts (for 2017, the solo 401k contribution limit is $54,000, whereas the self-directed IRA contribution limit is $5,500);The solo 401k business owner can serve as trustee of the solo 401k;The self-directed IRA participant/owner may not serve as trustee or custodian of her IRA; instead, a trust company or bank institution is required;When distributions commence from the solo 401k a mandatory 20% of federal taxes must be withheld from each distribution and submitted electronically to the IRS by the 15th of the month following the date of each distribution;Rollovers and/or transfers from IRAs or qualified plans (e.g., former employer 401k) to a solo 401k are not reported on Form 5498, but rather on Form 5500-EZ, but only if the air market value of the solo 401k exceeds $250K as of the end of the plan year (generally 12/31);When funds are rolled over or transferred from an IRA or 401k to a self-directed IRA, the amount deposited into the self-directed IRA is reported on Form 5498 by the receiving self-directed IRA custodian by May of the year following the rollover/transfer.Rollovers (provided the 60 day rollover window is satisfied) from an IRA to a Solo 401k or self-directed IRA are reported on lines 15a and 15b of Form 1040;Pre-tax IRA contributions on reported on line 32 of Form 1040;Pre-tax solo 401k contributions are reported on line 28 of Form 1040;Roth solo 401k funds are subject to RMDs;A Roth 401k may be transferred to a Roth IRA (Note that from a planning perspective, it may be advantageous to transfer Roth Solo 401k funds to a Roth IRA before turning age 70 ½ in order to escape the Roth RMD requirement applicable to Roth 401k contributions including Roth Solo 401k contributions and earnings.);Roth IRA funds are not subject to requirement minimum distributions (RMDs);The fair market value (FMV) of assets held in a self-directed IRA is reported on form 5498;The fair market value of assets held in a solo 401k are reported on Form 5500-EZ;At termination, the solo 401k is required to file a final Form 5500-EZ and 1099-R; andAt termination, the self-directed IRA is only required to file a form 1099-R.

William W. Humphrey · Answer

An IRA can take on debt, which could increase your buying power by more than double. Not all lenders will loan to an IRA that is buying a property, but New Direction IRA has a list of lenders that do. Also, keep in mind that your IRA can be a tenant-in-common with other owners (whether they be an IRA, a person, or a corporate entity).

Aaron Q. · Answer

thanks for the info Tracy, I am researching this and feel like traditional financing might be my best bet...$60k on it's own won't get me very far if it can't be combined with other non IRA funds. Thank you for your time.

Tracy Z. Rewey · Answer

@Aaron Q. Congrats on saving for retirement! The answer is YES, you can transfer or rollover funds from one retirement account to another without penalty or tax. The key is NOT taking possession of the money. Rather you want it to go from one institution to another to preserve it's current status. There are many IRA Custodians that have a multitude of free information on their sites on this topic or visit the official IRS.gov site. Not all custodians are setup to facilitate real estate investments which is where the Self-directed IRA comes into play.Please don't get overwhelmed by the in-depth discussion on UBIT/UDFI. I use to teach classes on IRA Investing to real estate agents for continuing education credits and those rules still make my head spin. It is good to be aware they can come into play when buying real estate using financing in an IRA. There are lots of other options out there as well.Please do take time to understand what is a prohibited transaction and a disqualified person when using retirement account funds to purchase real estate. This is the one I see tripping people up the most with some pretty big consequences.Happy Investing!

Aaron Q. · Answer

Thanks Carl, that does clear things up a lot. I do intend to research more before making any decisions.

Carl Fischer · Answer

@Aaron QuinnI believe you may be a little mixed up about the process of using a SDIRA to purchase real estate.First you would select a SDIRA custodian, then transfer a portion or all of your existing IRA to that account. Third, you would invest the funds into real estate. You can do this different ways, you can lend fund to a real estate investor, you can buy real estate directly, you can also invest in a real estate fund. Here is the important thing to note, the purchaser is your IRA, NOT you personally. The transaction occurs within the IRA and the funds are sent directly to the investment from the IRA. The owner of the investment will be something like: Name of custodian FBO Aaron Quinn IRA. You are not distributing the funds to yourself in this situation. The IRA would then own the investment and it would receive and credits or debits the investment generates. If your IRA purchases a property (123 main street) You can hold the asset in your account as long as you desire. One common investment method is the buy and hold strategy where your IRA buys 123 main street and rents it out. The rental checks would go back into your IRA as earnings. I hope this helps clear up some things. I recommend you do a little more research on these accounts before your first investment to make sure you follow the rules. I would be happy to connect and answer any follow up questions you may have.