Legitimate Self Directed Strategy or not?

[Scott Hubbard]

I was talking to another investor who proposed the following as a solution investors looking for more flexibility when using their SDIRA.

Two unrelated individuals arrange to make a loan to one another using their SDIRA funds. Terms of the loans are exactly the same including principal, interest rate, term, and the origination date. All things being equal, the required monthly payment would then be the same between borrowers.

The pro arguments for this arrangement would be the following:

1. Both borrowers would have control to use their "borrowed" money however they see fit.

2. This would be really cost-effective if your custodian charges access fees and moved your funds around a lot.

3. You could avoid UBIT.

4. IRS's non-recourse requirement would no longer apply, so you could utilize these monies as down payments.

5. You could expense the cost of capital and in effect shelter some of your earning as tax deferrred.

As an example: I can make a consistent cash-flow profit of 10% per annum. In finding a like-minded individual, I could essentially defer taxes on my earnings while still taking advantage of depreciation. The interest rate of the note would be just under the projected net income. My IRA grows through cash-flow contributions.

Cons would be:

1. Default would be a consideration.
2. Change in tax laws.

Has anyone made a similar arrangement? Doe sanyone see any possible issues with this arrangement? I wanted to run this by the mob before I take to my CPA. The last time came to her with a creative deal she just fell out of her chair.

[J Scott]

I've recently moved a large chunk of cash to an SDIRA, and I had a phone call last week with ERISA attorney to discuss this exact question...

The answer, of course, is complicated, and ultimately there is no way to know if you've violated the "indirect benefit" rule unless/until you were challenged by the IRS.

But, in general, the direction I was given was that you should avoid any obvious reciprocal loans -- in other words, loans for the same amount that originate at the same time with the same terms, etc, etc, etc. The more it appears that there is reciprocity in the loans, the more you are at risk of violating the rules.

On the other end of the spectrum, the advice I was given was that making *secured* loans (secured against real property) back and forth that were based on the price of the property (as opposed to the value of the loans going back and forth) should pose little risk.

To make the situation even better, my attorney recommended including self-serving language in the security instrument to the effect of, "This loan is made without the expectation of any return to the lender other than what is laid out specifically in this instrument," or something like that. Basically, calling out that there is no guarantee -- or even expectation -- of reciprocity.

Then there are all the situations in between the two I mentioned above. For example, unsecured loans of varying amounts and terms, secured loans at the same time, multiple parties involved in the various transactions, etc. And, the best answer I could get is that if the IRS or DOL determines that there is any type of reciprocal agreement -- expressed or implied -- that this would violate the indirect benefit rule, and there is no way to know if that's the case unless/until there was an audit (or unless I requested a determination from the IRS on whether what I wanted to do was legal).

As usual, I'm not a legal professional, but this summarized information came from my ERISA attorney directly.