All Forum Posts by: John Bowens

I like the step-by-step process, good for all SDIRA investors. 

I would add a step, that although is optional, is often used: 

Form an LLC, specifically for the use of IRA funds. IRA becomes the 100% owner of an LLC, or potentially multi-member LLC with multiple money sources, and the account owner of the IRA is the manager of the IRA owned LLC. You then create a bank account for the LLC. IRA funds LLC bank account and funds are deployed for investments and property held in the LLC.

Smart comment made on "not tapping into 401k." All too often I see folks borrowing against their 401k and then never pay back. Not only do they lose the retirement balance, but also they incur a 10% premature withdrawal penalty.  

In the spirit of order of operations, might be helpful to break down in this fashion: 

1) With your 401(k), do you have pre-tax money and post-tax Roth funds? If so, you will need to rollover those funds into respective money sources of pre-tax and Roth. 

2) Analyzing whether to use IRA or Solo 401(k), is fairly straight forward, when the intent is for you to have your own business and want to use the funds for real estate investing. Most likely you will establish a Solo 401(k), due to the additional benefits, some of which were already mentioned. If you have pre-tax and post tax Roth funds in the existing 401k, you will initiate a rollover into a newly formed Solo 401(k), with some funds dropping into the pre-tax bucket and Roth funds dropping into Roth bucket.

3) 3 benefits that I find many real estate investors are attracted to with the Solo 401(k): 1) Higher Contribution Limits (providing you have enough earned income) 2) Ability to contribute to Roth, without MAGI limits where you have to do a backdoor contribution, like you do a Roth IRA. 3) Exemption from UBIT/UDFI on debt financed real estate deals, this could be directly, or through a syndication type deal.

4) Now, we can proceed with, what about the caveats and qualifications to open and maintain a Solo 401(k): 1) You need to have earned income from the business/sole prop. that is sponsoring the Solo 401(k). Your contributions have to be recurring and substantial. I will say, being the industry for nearly 20 years, this is a huge problem. I see folks who have Solo 401(k)'s, but only have passive income. If all you do is own rentals for example, likely not qualified with a Solo 401(k). You might consider getting with your CPA and discussing a strategy to have a micro-business and show some earned income. 2) You can't have any W-2 employees, with the exception of yourself, a spouse, and any partners that own at least 5% of the business. (Keep in mind controlled group rules, meaning if you own a business with W-2 employees, you often can't just setup a side business and open a Solo without giving benefit to your W-2 employees with your main business - another area not often discussed in this industry until it is too late). 

5) Lot's of pros with Solo 401(k)'s as you can tell from above with the UDFI exemption on debt financed real estate and ability to make larger contributions. There can be more compliance work and potentially higher costs compared to just a Self-Directed IRA.

6) If you decide to rollover to a Self-Directed IRA first (your pre-tax money) you can always rollover that money into a Solo 401k when you eventually qualify. Just keep in mind, if you move money into a Roth IRA, you can't move from Roth IRA into the Solo 401(k). You can however move from 401(k) Roth funds into the Roth bucket of the Solo 401(k).

Hopefully this gives you some ideas to run with. 

This should not be construed as tax, legal or financial advice. This is merely education. Please work this material through your professionals and seek the proper advice. 

Not sure if I can answer your question exactly, but did want to say, great job on saving in a Roth IRA, Roth 401(k), and HSA. The power of tax-free compounding growth can be really meaningful over long periods of time. Far too many I have seen go many years with no retirement and then try to play catch up.

What is great about an HSA is that you get tax-deductions for contributions. Tax-Free growth and then you can distribute and use for healthcare and pay no taxes. You can also reimburse yourself for past healthcare expenses that you incurred while you had an HSA with funds in it. For example, you incur a $1,000 healthcare bill today and pay out of pocket. You don't take deduction on this. You grow HSA over years and then in the future you can distribute from the HSA tax-free to reimburse yourself. 

I think understanding the balance between active W-2 income and passive income is important. For example, I have seen many folks part of Bigger Pockets community build their rental portfolio through obtaining financing that they wouldn't otherwise be able to obtain if it was not for their W-2. Additionally, you have to consider healthcare, vision, dental, etc... 

Then you have to think about 401(k) and IRA savings, which longer-term once your balance is built up, you can use a self-directed approach whereby you can use the funds tax-free to invest in rentals, private loans, etc...

This message should not be construed as tax or financial advice. Merely responding to the post to provide some education. 

I agree with Ashish, great pointing out that although creating a property management type system could open up capabilities for Solo 401(k) and SEP IRA contributions, it can be easier said than done. In my experience, I hear of a lot of folks talking about this, but rare to see it actually be executed.

That said, Solo 401(k) with Roth component can be powerful and does open up the discussion with your CPA or tax pro about paying yourself more (within reason), in order to make higher contributions. 

I have done Private Money Loans on auctions in the past. I should preface this with, this is not an open door for me to loan, I do not offer my private money loans through this forum. I used my Self-Directed Retirement Accounts to loan on several sheriff sale auction properties in the past. I had  my borrower sign the promissory note and mortgage and then I went to the county recorder to record the mortgage. Likely best to have a real estate attorney handle this all for the private lender, unless they have experience or can navigate that process themselves. The attorney can assist with drafting the documents and recording the mortgage/deed of trust. 

Some private lenders are not willing to loan on auction properties, given the additional nuances and potential risk. 

Michael, 

You will most likely incur UBIT, using IRA funds. If you qualify for a Solo 401(k), you can roll pre-tax funds into the Solo 401(k) for the investment. Qualified Plans, including Solo 401(K)s are exempt from UBIT in the case of a debt financed real estate transaction. To qualify for a Solo 401(k), you need to have self-employment income, or W-2, within an owner only business, that is you are the only owner. Example, you have a business as a consultant, you make $10,000 in gross consulting income, 5k NET, which is subject to medicare and SS tax, this would qualify one for a Solo 401(k). You should consult with your tax professional on the matter.

Don't fear UBIT as we always say, just understand it. Keep in mind, if there is enough depreciation (IRA can't take the bonus depreciation, need to use standard depreciation schedule), that depreciation might negate any positive income. You may show losses that can be carried forward and offset future capital gains. What is the UBIT tax rate? See the estate and trust tax schedule, which for 2024, income over $15,201 is subject to a 37% tax rate. This is a graduated schedule, but accelerates quickly. Long-term gains is only 20% for income over $15,450. You should determine, are the returns strong enough to justify paying some UBIT, in comparison to investing in other investment products, such as what your IRA is investing in now.

A few additional items to help you: 

1) If you have a Roth IRA, a Roth IRA can't be rolled into the Solo 401(k), only pre-tax funds. You could do an in-plan conversion to the Roth side once moved into Solo 401(k).

2) You might want to talk to your CPA/tax professional about converting from the pre-tax to Roth, prior to or after you make your investment. Paying taxes on the seed rather than the crop. 

Hope this helps you for now. 

Thanks! 

My posts and reply should not be construed as tax, legal or financial advice. Merely posting for education purposes based on my experience working in the self-directed IRA industry for over 15 years.

Certainly, a lot that can be discussed, thank you for the post. I will just comment briefly on your retirement account you mentioned. I assume you have already heard, but you can self-direct your retirement funds into real estate. Note, if your 401k is all with the same employer you have always had, and you are still working there, you likely can't move it. However, if you have 401k money from a previous employer, you can do a rollover to a self-directed IRA and begin deploying that capital into real estate investments. That can potentially be rentals, real estate syndications, private lending, or other alternative investments.

You can also look at converting funds from pre-tax, to Roth IRA accounts, thus paying taxes on the seed so you don't have to pay taxes on gains/growth. This is known as a Roth Conversion, which does trigger tax as you are moving from pre-tax, to post tax Roth.

Thank you for well thought out post. I would also add with respect to Self-Directed account, Roth IRA/Solo 401k, with Roth Component. I look at it through the lens of:

1) If I contribute to a pre-tax account like a pre-tax 401k, Traditional IRA, SEP IRA, I get a tax deduction, but now I'm in a partnership with the IRS, but I don't know what I will have to pay them later on in life when I start pulling money out (that is because when you distribute you pay taxes based on your effective tax rate at that time, which can be unknown).

2) With Roth accounts, (Roth IRA/Solo 401k(k) with Roth component), I can get the taxes out of the way on the seed, so I don't have to pay on the crop.