Can I buy a rental with a relative through a self-directed IRA?

Question

Hello everyone!

I have been consuming all the great info from biggerpockets for 18months now but this is my very first post and I am excited to get insights, suggestions and particularly legal advice for my situation.

I recently got laid off from a company that I had been with for 6.5yrs (since right out of college) and then within a month, they offered me another role which is outside US so I am very excited about the change and new experience. I have a 401k balance of less than $100k that's still with the company but because my new role will be international, I won't be able to contribute to my 401k anymore. So my immediate thought is to rollover the balance to a self-directed IRA (between now and August when my new job starts) and buy a rental property. The kink in all of this is that I have $16k balance on a 401k loan that I am still repaying, that I took out to buy my primary residence two years ago. I have been looking into several strategies to pay it off and one of my first cousins (who is an international student in the US) has saved up $15k and would like to partner with me/ lend me the money to buy the rental.

My strategy was to use his money to pay off my 401k loan balance and then do the roll over into a self-directed IRA to buy the rental under my name so that he has the option to live in it (if it's a multi family) and rent the rest.

I have done a great deal of research and it looks like as long as I don't live in the rental and also make sure that all the transactions are done within the IRA, then it should be straightforward. But then again, since I will now be using some funds from my cousin, I want to be sure that there are no additional criteria or restrictions that I have to consider when structuring everything before moving forward with the plan to avoid penalties.

Thank you all in advance!

Alida

Alida Rwabalinda · Answer

Thanks so much, Dmitriy, for your feedback and for pointing out the key criteria to be considered. I will keep that in mind if I have to rent to him but will lean towards third parties. Thanks again!

Dmitriy Fomichenko · Answer

Alida, congratulations on the first post!

You would not be buying a rental with a relative. Relative would give you personal non-secured loan, you payoff the balance of the 401k loan, rollover funds into self-directed IRA and then IRA would buy a rental property. This purchase would not be under your name, it would be under the IRA (specifically IRA custodian will take the title for the benefit of your IRA unless you are using Checkbook IRA). Moreover, if you decide to rent the property to your relative, it must be at the market rent, you can't give him any concession because of the personal loan he provided to you to pay off your 401k loan balance. My recommendation is to not even have this as an option, rent to unrelated third parties and stay out of trouble.

Please keep in mind that the loan to your relative must be repaid with the personal funds, you can't use rent proceeds for that. All income from the investment owned by the IRA must be going into an IRA and all expenses related to the investment must be paid from the IRA as well.