Reciprocal Private Money Financing via SDIRA - Does this work

[Chris Soignier]

I recently left full time employment to start investing in RE full time.   Until now, I've been primarily concerned w/ passive MF investing, but the returns aren't yet sufficient to cover more than a small portion of my former salary.  I want to engage in the full gamut of activities, including wholesaling, sub to's, fix and flips, and ideally fix and holds (for at least a year).    

I have a pretty good amount of capital available, but the problem is that the majority of it is tied up in my IRA's, w/ the 2nd largest chunk being in my illiquid MF investments. SDIRA transaction rules seem pretty tight against using the money for any personal benefit outside my IRA. What if a friend and I set up a reciprocal lending arrangement w/ our respective IRA's? Let's just say we lent each other $200-300K simultaneously on an unsecured basis, or allocated a similar amount to fund 70% of ARV on rehabs as they're sourced?

Do any of you know if this would run afoul of any of the IRS' regs?   If not, any other pitfalls I should be aware of?   I normally wouldn't want to borrow from friends, but would have enough reserves to pay off the loan worst case.

[Jeff Rabinowitz]

If you find yourself looking for a loophole with SD IRA funds you should stop immediately. The penalties are too severe to take the risk. Normally, if you take an aggressive interpretation of a tax deduction the risk is not too great. As long as you have documentation and a decent argument the worst that would happen is that the IRS would make you pay the tax you owed anyway and the interest. It is worth being aggressive. That is not the case with SD IRA accounts. If you are caught violating the rules (and your scheme is a clear violation) the IRS will consider that you distributed your entire account. You will have to pay the early distribution penalty if your are under 59 1/2 years old, the entire account will be subject to taxation and you will not be able to restore it. Again, the penalty is too severe to take the risk.