Solve the Puzzle. Craft a Deal. Part Deux.

     I concluded the first part of this story by suggesting that there might be a way to make what would be a good deal even better. This is the link to Part 1.

     What if I bought this property through my self-directed Roth IRA? Under ordinary circumstances I would not consider buying a rental property through my IRA. Doing so wastes the tax benefits of owning rental property. One cannot realize a tax benefit in a tax exempt account. In this case, since I planned on selling the property immediately, I would not be entitled to claim a tax deduction for depreciation so this did not apply.

     Though I am a careful investor and a good record keeper there is always a risk that an IRS agent might poke around and try to claim that managing a rental property was self-dealing. That assertion, if proved, could destroy the value of an IRA. I know I could reduce that risk by hiring a property manager but something unexpected could come up. What if the property manager inadvertently paid a bill for this property outside of the IRA? What if the neighbor calls and alerts us to the fact that water is pouring out of the house during Winter? (I live in Michigan, this is a sign of broken, frozen pipes and it does happen.) I live nearby. Would I be content to let the water flow until the property manager could address it or might I run over and secure the property myself? Might an IRS agent looking to claim half of my IRA for the government consider this self-dealing? I wouldn’t usually take the chance.

      This transaction is considerably less risky than operating a rental through my IRA. My IRA will own the property for the few minutes it takes to sign the land contract agreement and the memorandum. The property will be transferred on the tax rolls and the investor/buyer will be responsible for the maintenance of the property, keeping it rented, placing insurance and paying taxes. (This investor actually delegates much of the operation of the property to a professional property manager.) I will have no direct involvement with this property. It seems it would be quite a stretch for an IRS agent to claim I was self-dealing now.

     There was a major obstacle to purchasing this property in my IRA. I did not have enough funds available. I did have a few notes outstanding. I called one of the borrowers. They had enough funds available to cover the difference between what I had available and what I needed. They agreed to pay down their note. (I am fortunate to work with people whose success I care about and who care about mine.) While we were on the phone they mentioned that they had another deal coming up soon and they wanted to know if I would like to partner on it. It sounded like a solid deal and since this investor is someone I have partnered with frequently I was able to give preliminary approval to the next project (contingent upon the supporting documentation verifying the scenario—I have no doubt it will). So, I secured the means to purchase this property through my IRA and also set up another investment which will be funded through a different entity.

     This investment now functions much like an investment in a note secured by real estate. Since it is held in a tax free account there will not be any adverse tax consequences to me if the property is sold within a year. I can remove any restrictions concerning the holding time for my buyer. A quick sale will increase my ROI considerably. I have done several deals with this investor and have a high level of trust in their character and ability to perform so I required only a small down payment (some of which was provided by the tenant (seller) in the form of a security deposit and first month rent). My buyer adds a rental property with built in equity to their portfolio that cash flows immediately for little out of pocket cost. I gain an income stream into my IRA which is secured by the equity in the property and which will provide a nice profit when the investor cashes out the land contract. (The land contract is for only 3 years with a balloon payment due at that the end of the 3 year term.)

     This deal had a lot of moving parts. It may not have been worth doing if the pieces could not have been placed in the correct configuration but once the puzzle was solved it became a nice profitable deal.