All Forum Posts by: Brian Eastman

@Robert Karnes

Both an IRA and Solo 401(k) can use debt financing such as a mortgage. The difference is that an IRA is subject to tax on the portion of income the IRA receives from the non-IRA money in the deal and a 401(k) has an exemption from that tax when the debt-financing is used for the acquisition of real property.

The UBIT cost of UDFI does not normally add up to that much in an IRA, and the net effect is a small reduction in the boost of returns that leverage creates, so it is still a net positive strategy.  Of course, if you have the option for a Solo 401(k) and can eliminate both the tax and the headache of a separate tax return for your retirement plan, that is a win.  

The exemption from tax on UDFI in a 401(k) applies whether the funds in the 401(k) are tax-deferred or Roth.

Be advised, UDFI (debt-financed income) is exempted, but UBTI (business income) is not.  Those are two different forms of income that generate an obligation to pay UBIT. 

@Robert Karnes

Your plan is generally solid. The IRA can long-term lease the property to someone who will then be a short-term operator.

Unless you plan to acquire the property using mortgage financing, an IRA and Solo 401(k) will be largely similar. If you plan to use a non-recourse mortgage for the property, then looking for a legitimate fit for a Solo 401(k) could be worth your while to avoid tax on Unrelated Debt Financed Income (UDFI). Beware internet promoted schemes like being your own property manager. That is "technically" feasible but not always net-beneficial. There are a lot of trade-offs, complexities, and expenses involved that can effectively cost more than the amount of tax being paid on UDFI by an IRA. Why spend $1000 to save $800, figuratively speaking?

A fixed rent from the operator would clearly be passive rental income not subject to tax on Unrelated Business Taxable Income (UBTI).

The percent of revenue approach would be more aggressive. It {could} if structured properly still be considered passive income, but it could also be viewed by the IRS as operating business income subject to UBTI. You would definitely want to engage a tax attorney to consult on that topic. These are the types of interpretive details where if you ask 4 tax professionals you will get at least 3 answers. So, you just kind of have to determine how aggressive you want to be and what is the worst case scenario if 3+ years in the future the IRS determines you had a failure to file on UBIT. In addition to the tax, you will tack on penalties and interest. It does not disqualify the IRA, but it would result in a big dent in your returns.

The better approach may be an agreement with the operator for a higher than market rent due to the intended use, or perhaps some kind of periodic maintenance surcharge to cover the additional wear and tear of short term rentals.

@Cariza Abinguna

A self directed IRA would be a tool you could use to keep the money in a tax-sheltered retirement plan but give the plan the option of investing in real estate rather than just being limited to the stock market. A former employer 4010(k) can be rolled over to a self-directed IRA or self-directed Solo 401(k).

To be clear, this is not a means for YOU to start investing in real estate, and it sounds like that may be your real goal. The IRA owns the real estate and receives the income in a tax-sheltered fashion, just like your 401(k) does today. This is a means to diversify your retirement savings investments. You cannot personally derive income other than by taking taxable distributions from the IRA, normally after age 59 1/2.

@Account Closed

Either an IRA or a Solo 401(k) can be self-directed. The Schwabs and Fidelities of the world do not offer those services and their staff are not at all trained on the topic, so when they say "A Solo 401(k) cannot invest in real estate", what they really mean is "our Solo 401(k) can only invest in the stock market."

You will want to reach out to a specialty firm that offers self-directed IRA and Solo 401(k) plans. Several of us are active here on Bigger Pockets.

@Jared W Smith

Why ask an internet forum when your plan provider should be able to assist you with this very common question?

You do not need a LLC. You need a banker that understands the difference between a 401k trust and a LLC.

There are advantages to working with a bank like Solera National Bank that actually understands the Solo 401(k) structure, namely that you do not need to educate the banker on how to do their job.

@Tiffany A.

There are several companies active on Bigger Pockets that specialize in providing investors with checkbook control.  That type of structure is typically superior to using a custodian as a processing agency when it comes to real estate investing.

The most important part of the service is ongoing guidance and education.  Focus on that piece as you evaluate providers.

@John Smeltzer

An IRA is tax-exempt. The only tax implications are when you take a distribution from the IRA, and all IRA's are taxed the same. A self-directed IRA is just an IRA with different investment choices.

@John Smeltzer

As a plan provider, I cannot make a specific recommendation as to a company to work with per BP guidelines.  I can tell you this is a fairly small space and there are not any meaningful providers in Savannah.  Expertise will definitely be more important than location.

Self-directed IRA's come in several formats offered by different types of companies. The type of self-directed IRA that will best suit your situation and goals will drive the process of identifying the right firm to work with.

A self-directed IRA custodian is a processing entity. Think E*Trade or Fidelity with different paperwork. All IRA based plans are required to have a custodian to administer and report on the account. What makes a self-directed IRA custodian different is that they are not purely connected to the public exchanges and limited to investing in stocks, bonds and funds, but rather have the staff training and paperwork to document the IRA's investment in the more individualized transactions that occur when investing in real estate, notes and other non-traditional assets. Such custodians will hold funds, sign documents, issue expenses and receive income on behalf of your IRA and act as your processing layer. This works OK for relatively static and simple investments like a private placement or crowdfund, but can become rather cumbersome and expensive with a more time sensitive and transaction intensive asset such as a rental property. You also need to be aware that custodians are passive in nature and simply process transactions at your direction. They do not provide meaningful oversight or guidance with respect to tax code compliance.

A checkbook IRA LLC is an enhancement on the above structure that is generally more time and cost efficient for investors with a more diverse portfolio. It starts with a self-directed IRA held by a custodian, but the IRA simply makes one investment into a specially designed LLC entity. The IRA owns the LLC, but you can be the non-owner manager of the LLC and have signing authority. This allows you to directly manage transactions via the LLC and eliminates the paperwork, processing delays and per-transaction fees of the custodian. These plans typically cost a bit more to establish due to the legal work, but in most cases will save you considerably over the long term. With a quality provider, such plans also come bundled with meaningful consulting guidance to help you get the most out of the program while staying inside the IRS guidelines.

A similar checkbook program is a Solo 401(k). Such plans are available to those who have some form of self-employment and no full time employees. As an owner-only business retirement plan, the Solo 401(k) has higher contribution limits, allowing you to build your savings on the front end as well as providing investment flexibility. The Solo 401(k) also has the advantage of being more favorable for real estate investments using debt-financing such as a mortgage - as the 401(k) is exempted from a small tax called UDFI that an IRA would pay on the percentage of income derived from the borrowed money.

So, as you continue your research and get feedback here on BP, think about what type of program will best suit your needs and be sure to ask questions along that line. Get on the phone and speak with a few of the providers that are active here on BP. You will pretty quickly be able to tell who is just selling something and who can become a valuable member of your team.

@Jon Saddler

Forming a LLC does not convert passive rental income into earned income. Generally speaking, unless you are managing quite a few doors, it does not make sense to try to change favorable passive earnings into earned income. Check with your CPA, but it sounds like if you want to pursue a self-directed investment strategy, and IRA may be the only available route at this time.

@Jon Saddler

A self-directed Solo 401k is a great way to diversify your retirement holdings, but is entirely separate from your personal goals of scaling your real estate portfolio.  When a Solo 401(k) invests in a syndication, all income goes tax-sheltered back into the Solo 401(k).

In order to sponsor a Solo 401(k), you would need to have some kind of self-employment that creates earned income, such as consulting, being a licensed realtor, etc.  Having a portfolio of rental properties as you describe does not qualify to sponsor a solo 401(k), because rental income is passive investment earnings, not the kind of compensation that can be used to fund a retirement plan.

So, while some of your goals are on-target, the pathway there may be different than you are envisioning or describing here.  Get together with your tax strategist and a self-directed retirement professional to further your education and get on the right path.