SDIRA/401k questions

[Scott Sauri]

First of all, thanks to everyone who takes the time to post on this site. I've been reading for a few months now and have learned a lot. This is my first post and I hope this thread isn't too old to be commenting on now, but after some searching, this seems to be the closest to what I am looking for.

I have already converted an old 401k to a SDIRA and used that to fund a checkbook/IRA LLC. I am currently looking at properties and there a few that I can buy outright, but I have more options available if I decide to finance (obviously).

My questions are regarding the financing. From what I can tell there are only a few lenders that make non-recourse loans and I am currently working with someone from NASB as they seem to be the most referenced national lender in this area.

However, after reading this thread, I am now wondering if I should be borrowing against my current 401k rather than obtaining financing from NASB.

1. Can I borrow money from my current 401k and then lend that money to my SDIRA LLC? Can I or my 401k even make a non-recourse loan to my SDIRA LLC at all?

2. I'm reluctant to borrow the money to partner personally with my SDIRA LLC on a deal, because I am worried about that creating a prohibited transaction since I can't really afford anything on my own without investment account money. Although I'm not really clear on
the rules there.

For example, if I have $100k in my SDIRA LLC and $200k in my current 401k, could I borrow $100k from my current 401k to buy a $150k property? Would this not be considered a prohibited transaction because I, technically, could have afforded the property on my own by borrowing $150k from current 401k?

3. This is really a separate, but related, question. Given the above account balance examples, even if I decided to buy a cheaper property outright with my $100k SDIRA LLC, would it make sense to borrow against my current 401k to buy a second property outright? The cheaper properties that I am looking at are between $60k and $90k and would likely get a rent between $900 and $1100. Those numbers seem in line with what Mark H. was calling a good deal earlier in this thread.

What is the downside to doing this? Just the risk that the real estate investment will not perform as well as the mutual funds that those funds are currently invested in?

Sorry for the long post!

[Jon Holdman]

$54,000 / $60,000 = 9%. A $60K loan at 9% interest for one year would return you $5,400. Not sure how you got to 16%.

If you were to make hard money loans to a rehabber, getting 12% interest would be on the low end for such loans. If you could keep the money at work all year, you would get $7,200 back per year. Trouble is, when one loan pays off it may take a month or two before you can get the money loaned out again. And a borrower may need $45K or $50K, leaving you with money in the bank earning very little. I used to do exactly this. The broker I work with has moved to a pooled model instead. Me and other investors put our money into the pool and he uses that to make the loans. We get back 8% as a base, then additional payments based on the actual earnings. There's still times when some of the money isn't earning the full return (15%, by the way), but that gets spread across everyone in the pool. So returns really are pretty close to 12%.

It doesn't matter if you create an entity or not. When two parties (i.e, you and your IRA) do something together you have created a partnership as far as the IRS is concerned. You need to keep track of what the partnership does and how the money comes and goes. Each of you will need to account for it.

UBIT is the killer for owning real estate inside an IRA. If you simply work through the math for owning a property free and clear vs. owning one with leverage, using leverage almost always produces higher return. There is, of course, more risk. If values fall, all that loss is coming out of your down payments. A fall of 10% on a free and clear property loses 10% of your money. OTOH, if you buy four similar properties with 25% down each, and they lose 10%, you're losing a total of 40% of your money. Yes, you can reduce the taxable income by the depreciation amount. But if you have taxable income (and good rentals produce taxable income, not losses), UBIT kicks in. If you get to $11,000 of income, you're looking at a marginal rate of 35% for UBIT. You have to be in a pretty high income for that to happen with rentals you own directly. So, you're taking an investment which already gets advantages for tax treatment and putting it into a tax sheltered account. My math says this just doesn't produce as good a return as owning property directly.

Keep in mind that if you down own property in your IRA, and you later distribute the property or the income from the property, you will still pay tax on that. So, its entirely possible to be paying UBIT on some of the income AND paying regular tax when you take the earnings for yourself. This is, of course, exactly what's happening when you own stocks. The company pays tax on their earnings, and then you pay taxes on your earnings, too.