Real Estate Broker · North Richland Hills, TX · Member since 2013 · 1k+ posts · 607 votes
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.
Investor/Landlord · Farmington Hills, MI · Member since 2011 · 1k+ posts · 1k+ votes
11y
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.
Investor · North Idaho · Member since 2011 · 332 posts · 107 votes
11y
Brian is right. Here is the code from 4975 explaining prohibited transactions.
(c) Prohibited transaction
(1) General rule
For purposes of this section, the term “prohibited transaction” means any direct or indirect—
(A)sale or exchange, or leasing, of any property between a plan and a disqualified person;
(B)lending of money or other extension of credit between a plan and a disqualified person;
(C)furnishing of goods, services, or facilities between a plan and a disqualified person;
(D)transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a plan;
(E)act by a disqualified person who is a fiduciary whereby he deals with the income or assets of a plan in his own interests or for his own account; or
(F)receipt of any consideration for his own personal account by any disqualified person who is a fiduciary from any party dealing with the plan in connection with a transaction involving the income or assets of the plan.
Real Estate Broker · North Richland Hills, TX · Member since 2013 · 1k+ posts · 607 votes
11y
Thanks to both of you for your feedback. I was thinking the reciprocal arrangement would be informal and not in writing, but I can appreciate that the penalties for non-compliance are pretty severe, so I don't want to test the limits of what I can do here.
Investor/Landlord · Farmington Hills, MI · Member since 2011 · 1k+ posts · 1k+ votes
11y
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.
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.
I agree with Jeff, I am in NO WAY condoning loopholes or tricks or pushing the limits of what you can get away with when it comes to taxes and the IRS.
But...
If you are the type who likes to "get over on ole uncle sam" so to speak, then at least do it in a way that limits your risk. Take chances on things with relatively small penalties if you want to take chances, not on your SD IRA which can be fully and immediately distributed as of the first of the current calendar year if you are involved in a prohibited transaction.
I guess what I'm saying is if you're going to do something illegal, speed, don't murder someone.
Real Estate Broker · North Richland Hills, TX · Member since 2013 · 1k+ posts · 607 votes
11y
Just to be clear, I don't have any intention of doing anything illegal or unethical w/ my REI business....I was just trying to be creative and looking for an interpretation as to whether it would pass the rules.
I know I can lend private money to others (and probably will once I set up my SDIRA). I suppose it would be OK for them to lend to me as well provided there's no reciprocity provisions to our respective lending relationships, or should I avoid lending to and borrowing from the same person?
Investor · Sarasota, FL · Member since 2008 · 17k+ posts · 17k+ votes
11y
I've talked to an ERISA attorney about this exact situation...here was his feedback...
It's clear that any reciprocal arrangement violates the statutes. But, there is nothing inherently wrong with you lending him money (at fair rates) and him lending you money (at fair rates) from your respective IRAs.
The key is that there is no real or perceived reciprocity. That would mean that it should be clear from the lending pattern that he lends to you INDEPENDENT of your lending to him and vice versa.
I have done this with other investors, but there has never been any agreements between us (not even the wink-wink kind). I lend to them when they need it (if I have the cash available and I am comfortable with the deal) and they lend to me when I need it (if they have the cash available and are comfortable with the deal). Sometimes, they'll lend to me multiple times in a row and I won't lend to them at all. Sometimes the other way around. For higher risk deals, the interest rate is higher; for lower risk deals, the interest rate is lower. There is no direct relationship between the rates I charge them and the rates they charge me. We typically charge "market rates" for private loans, so the rates are similar, but not correlated.
I'm completely comfortable with this arrangement based on the advice of my attorney. That said, I'm not an attorney myself, and this is not legal advice I'm providing...just second hand legal advice and my personal opinion/experience...