Using self-directed IRA to purchase buy and hold properties
Real Estate Agent · Omaha, NE · Member since 2017 · 26 posts · 19 votes
I would like to learn more about the use of an IRA for the purchase of buy and hold properties. Are these properties held in an LLC that your own or in your personal name? Can you use these funds for any property, whether it be single family or multi unit/conversion, or does it need to be an approved property? My cash flow from this property would go back into the IRA correct? If we need any repairs or updates would those come from the IRA? How does this work if I use funds from my IRA for a down payment and take out an a loan for the rest? Would my mortgage payment come out of the IRA? How does that work when it comes time to taxes and write offs?
Out of curiosity, what did you pay to set up your self-directed IRA and how much do you pay annually?
A self-directed IRA can be used to diversify your retirement savings into real estate such as a rental. The key thing to keep in mind is that this is about the IRA investing in real estate rather than investing in stocks - not you investing in real estate and getting to use your tax-sheltered IRA money to do so.
All aspects of the investment are conducted via the vehicle of the IRA (which can take a few formats - more below). The IRA owns the property, pays for all expenses of acquisition and maintenance and receives all income. Of course, the income is tax-sheltered into the IRA, just as income from stocks/funds is sheltered.
An IRA may invest in any kind of property and you will choose the investment. We have clients investing in land, single-family rentals, commercial complexes, apartments, etc.
You may invest in property using the services of a self-directed IRA custodian or 3rd party administrator. In that model, the institution holds the funds, signs every document, pays for all expenses and receives all income. They are the processor for the IRA, following your instructions. This works OK for more static deals like buying into a syndicated apartment deal, for example.
For direct ownership of rental property, having such a self-directed IRA invest into a specially formed LLC is generally more efficient. The LLC is owned by the IRA but you can be the manager and direct the affairs of the LLC without needing to go through the custodian for each and every interaction with the property. This is called a Checkbook IRA. This can also be done in a Solo 401(k) plan if you are self-employed with no full time employees.
An IRA may use a mortgage. The loan must be non-recourse, meaning no personal guarantee from you. The use of debt-financing in an IRA does create a small tax liability via UDFI taxation. This is not a deal killer at all, but something you will want to understand.
There is lots of good info here on BP and several providers are active on the forums.
A self-directed IRA can be used to diversify your retirement savings into real estate such as a rental. The key thing to keep in mind is that this is about the IRA investing in real estate rather than investing in stocks - not you investing in real estate and getting to use your tax-sheltered IRA money to do so.
All aspects of the investment are conducted via the vehicle of the IRA (which can take a few formats - more below). The IRA owns the property, pays for all expenses of acquisition and maintenance and receives all income. Of course, the income is tax-sheltered into the IRA, just as income from stocks/funds is sheltered.
An IRA may invest in any kind of property and you will choose the investment. We have clients investing in land, single-family rentals, commercial complexes, apartments, etc.
You may invest in property using the services of a self-directed IRA custodian or 3rd party administrator. In that model, the institution holds the funds, signs every document, pays for all expenses and receives all income. They are the processor for the IRA, following your instructions. This works OK for more static deals like buying into a syndicated apartment deal, for example.
For direct ownership of rental property, having such a self-directed IRA invest into a specially formed LLC is generally more efficient. The LLC is owned by the IRA but you can be the manager and direct the affairs of the LLC without needing to go through the custodian for each and every interaction with the property. This is called a Checkbook IRA. This can also be done in a Solo 401(k) plan if you are self-employed with no full time employees.
An IRA may use a mortgage. The loan must be non-recourse, meaning no personal guarantee from you. The use of debt-financing in an IRA does create a small tax liability via UDFI taxation. This is not a deal killer at all, but something you will want to understand.
There is lots of good info here on BP and several providers are active on the forums.
@Ryann Kluthe
Your questions were pretty much already answered. Essentially the property would be owned by the retirement account and all the income and expenses would flow through the retirement account. Following is more information regarding the solo 401(k) and the IRA LLC.
The Self-Directed IRA and Solo 401k Similarities
The Self-Directed IRA and Solo 401k Differences
Lastly, for a list of banks that will loan funds to an IRA or solo 401k, see the following:
https://www.biggerpockets.com/blogs/9552/70408-ira-and-solo-401k-non-recourse-lenders
Great info from @Brian Eastman
If you use the Ira money for the down payment the Ira would most likely obtain the non-recourse loan as Brian discussed. All income and expenses go into or out of the Ira or checkbook Ira account.
When it comes time for income taxes there is no tax on the income unless your Ira obtained a loan. In that case your Ira may have to pay unrelated business income tax UBIT reference irs form 990t which is subject for another forum.
To setup an account is approximately $50 with a SDIRA company and if you go with a checkbook LLC it ranges between $500 and $1500 as well as state fees for the LLC. There are annual fees associated with the IRA custodian (approx $275)and sometimes state fees with the LLC- state dependent. Verify with SDIRA administrator fee sheets and with the checkbook ira LLC. Provider for actual costs.
As a real estate agent, you are likely eligible for a Solo 401k which works very similarly to an IRA LLC, but has many additional benefits.
Compared to an IRA, Solo 401k contributions limits are roughly 10 times higher and there is no custodial requirement for the 401k. This means you don't need the additional expense and administration of an LLC to have checkbook control. You can take participant loans from a Solo 401k, but not an IRA. Built-in Roth components, spousal contributions, and an additional tax exemption also apply to the Solo 401k. Solo 401k plans are often quicker to setup and cost less money over time especially compared to most IRA LLCs. Prices for many Solo 401k providers range from about $500 to $1200 with annual fees often between $100 and $200.
Self-directed IRAs usually come with a fairly low account setup fee from the custodian, but higher ongoing costs depending on the IRA asset value and transaction volume. Adding an LLC for checkbook control often reduces the ongoing fees to the custodian, but will come with a larger setup fee to a facilitator as well as formation and ongoing filing fees to one or more Secretaries of State.
So great to have all my questions answered by experts! Thank you everyone. It did drum up so more questions for me when I was reading the answers.
For myself, i do have a Solo 401K. however I'm curious about the IRA for clients that are interested in purchasing buy and holds.
Can you charge yourself a property management fee out of the IRA?
Also, if you sell the property, would the IRA have to pay capital gains?
If so, could that fall into a 1031 exchange?
Are there no tax deductions for interest and depreciation?
1. No, you cannot get compensated for managing the IRA, and generally you can only perform managerial functions on a limited basis to not run afoul with the self-dealing rules.
2. No, capital gains does not apply to to property owned by a retirement account.
3. Depreciation does not apply to property owned by a retirement account.
The same prohibited transaction rules that apply to the Solo 401k (hopefully you are aware of these since you have a Solo 401k) also apply to the IRA.
The IRA accountholder cannot receive any management fees or otherwise transact with their IRA. Much like the Solo 401k, the sale of assets within the IRA does not result in taxation. These are tax-deferred accounts. There is no need for a 1031 exchange to receive that benefit within an IRA or 401k. If there is no taxation within the IRA or 401k, there is nothing against which to take depreciation.
We have many real estate agent clients who work with investors to purchase real estate in self-directed accounts. For investors who are also Solo 401k eligible, that is probably the way to go for them. For those who are not, a self-directed IRA (perhaps with an LLC for checkbook control) is a good option.
Ryann,
It is crucial for your own sake and for the sake of your clients that you understand prohibited transactions rules outlined by the IRS:
https://www.irs.gov/retirement-plans/plan-particip...
They are not difficult to understand, and once you understand them you will be able to answer all of those questions yourself. This will also help you keep your clients out of trouble and they will love you for it. Unfortunately in this industry not everyone who claims to be an expert has full understanding of the rules and I've seen bad advice given to folks. It's OK to ask questions and seek guidance from professionals but you'd want to know the basics yourself so you can have discernment.
@Ryann Kluthe you are getting some great feedback here.
I have both SDIRA and SOLO401K. The main reason I have the SDIRA is because I did not yet know about SOLO401Ks when I set it up, and it is a ROTH SDIRA so it can not be converted over to the SOLO401K.
I just wanted to point out that there was a discussion here on BP a year or so ago talking about when a 1031 *might* apply. Basically, IF you were using financing in a SDIRA and UDFI taxes were an issue, at that point normal expenses such as depreciate become deductible expenses to the extent that you are using financing - meaning if you borrowed 50%, that then 50% of depreciation is deductible.
I *think* that if you sold that property while there was still a loan on it (not paid off yet) that there would be UDFI due on *part* of the capital gains, even though it is held in a retirement account. This is where you could use the 1031 within the retirement account to defer that tax.
This was my understanding of what one of the providers who was active on here at the time was saying. Just food for thought that you should check with an expert on.
Dan Dietz
@Dmitriy Fomichenko I totally agree with you. I don't rely on just myself to give this kind of advice. I always make sure to tell clients they should seek the advice of an accountant, lawyer, or financial advisor for issues that I do not have full knowledge of. I would prefer to either get some kind of formal education on the matter as I have with real estate if I am going to be giving out advice. These questions are merely for my information and brainstorming ways for clients to come up with buying power. Thank you for the link.
@Ryann Kluthe, there are certainty resources out there that you can use to educate yourself... I'll send you a private message with couple links.