Using a Self-Directed IRA for Multifamily Apartment Syndications?

Question

This is a very debatable topic but...I have a self-directed IRA. I have only used that IRA to invest in private notes and hard money lending because those types of investments produce "interest" income which adds to my ordinary income tax bracket levels. On the other hand, apartment syndications have tax advantages such as depreciation that lower my taxable income brackets. My thought has always been, why place a tax-advantaged asset (such as an apartment syndication) into a non-tax advantaged account (such as an IRA). Wouldn't you be throwing away tax advantages since a traditional IRA is taxed at ordinary income tax rates (when the funds are pulled out)? Lately, I have been hearing that more and more people are using their self-directed IRAs to invest in real estate syndications. I'd love to get your thoughts on this. Thank you for the comments.

Michael Swan · Answer

@Travis WattsIn 2011-2012, I sold approximately $200,000 in Self-Directed IRA and invested in 10 rental properties one at a time with 25% down payments. I paid the stupid penalty for investing in those money pits and the taxes and had $50,000 a year, primarily taxed deferred cash flow in those 10 rental condos and 3 years later they doubled in value. I told my story on Podcast 238. In 2015, 2016, and 2017 I 1031 exchanged them for 6 apartment complexes and deferred my taxes to buy 8 apartment complexes in NE Ohio. Now I have $180,000 cash flow and rising!! Not to mention I am increasing the NOI and vastly increasing the value of my apartment complexes too. To think in 2011, before buying my first little rental condo, I was only making combined before taxes and deductions family income of $80,000 gross per year. I still teach PE because I love it and am only 54 years young!! If I can do this, anyone can.Swanny

Brian Eastman · Answer

@Travis WattsThe appropriate question to ask is whether an apartment syndication produces better results than any other investment the IRA might make. If so, then it is a good investment for the IRA. Whether an investment within an IRA would be more or less favorable based on tax considerations that do not apply inside of an IRA is a moot point.

Todd Dexheimer · Answer

You do miss out on the tax advantages of depreciation, but at the same time you don't have to pay it back or pay for the taxes when the real estate is sold. The other thing to think of is that you don't get any tax advantages in any other asset class, such as stocks, bonds, metals, etc. I would look at what produces the highest yield with the safest returns (It starts with real and ends with estate)

Jay Chang · Answer

Have you thought about Roth self-directed IRA? You should be able to backdoor your traditional IRA to Roth IRA and then make a self-directed IRA. This self-direct will then be completely tax-free. The issue is that you'll have to pay tax upfront.

Travis Watts · Answer

@Brian Eastman That is an interesting perspective, I see your point. Thank youI guess my question really is IF you had the chance to do the deal either with your IRA or with all cash. For example, If you could make 10% inside your IRA and be taxed later at a 30% bracket upon withdrawal, that's a 7% net return. On the other hand, if you could make that same 10% on a cash investment and pay 0% in taxes due to depreciation, that would be the equivalent to a 13% investment inside an IRA. In this case, I would say cash investment would be best. But I understand your point of....what else are you going to do with your IRA funds if you invest with cash? You must have other opportunities on where to put that capital to work.

Julian Sanchez · Answer

@Brian EastmanThanks for the response, Yes that is what I was referring tounderstood.

Brian Eastman · Answer

@Julian SanchezIf by "one of our syndications" you are referring to a deal where you are a GP (or part of a team that is teh GP) then your IRA cannot participate.An IRA is tax sheltered. To retain that tax-favored status all investments must be at arm's length and may not directly or indirectly intersect with you or other disqualified persons.If you know and understand an asset like multifamily, you can setup a self-directed IRA and invest in deals sponsored by others.

Julian Sanchez · Answer

Better yet, how can I use an SDIRA to invest in one of our syndications?Currently the money still sitting in a 401k with fidelity

Trevor Ewen · Answer

@Travis WattsYou're right to suggest that you do not get 100% of the tax benefits, but you still receive many of them. For instance, your distributions will be taxed, yearly. Also, there will be a significant capital gain on the sale of the asset (which many syndications presume), and that will also be taxed. The main thing you lose out on is the defense you get from depreciation. The value of an investment project (NPV or whatever analysis you use) is always based on the best nearby alternative. Maybe you ran out of taxable funds but found a really great project and have the SDIRA available. There is no sense in waiting years for a more tax-intensive investment. Assuming you always have an infinite number of options available, you'll want to put the high-tax projects in the SDIRA, but that's not always how the timing works out in my experience.

Dmitriy Fomichenko · Answer

@Travis WattsIF you had $50K in savings and $50K in your self-directed IRA and were considering investing in apartment syndication and investing in a note - you would be better off doing a private loan inside of your IRA and investing in syndication personally. However, that is not the case for most people. Most people have some $$$ in an IRA invested in stock market and looking for better alternatives. If you run the numbers and come to the conclusion that investing in a syndication will yield better results for your IRA - then that would be the route you should take. This has nothing to do with losing tax benefits. You are not losing anything. You are investing inside of the tax-deferred vehicle. Your investment grows tax-deferred. I personally love investing in notes, been doing that for several years. But as I continue to do so every year the amount of interest reported to me on 1099-INT grows and I end up paying more and more taxes. So I am making some changes in my investment strategy and shifting into syndications (so I can get some tax benefits). You have to evaluate each investment individually and don't confuse yourself. Invest into what makes sense and will provide you with the best bottom line.