All Forum Posts by: Brian Eastman

@Darryl S. 

We have hundreds of clients doing exactly what you propose. Using a Roth IRA or Roth Solo 401(k) to invest in real estate.

The field is complex, and you will want to speak with an industry expert and/or tax advisor.

A key consideration is that the type of transaction you describe - flipping houses - is not entirely tax free even under the umbrella of a Roth IRA. The issue is that IRA's are tax exempt when earning passive income. When engaging in a business like flipping houses, there is a trust tax referred to as UBTI that applies (see IRS publication 598).

The UBTI tax can get to be as high as 39.6%. So is flipping in an IRA better than flipping outside an IRA? Not really. That said, however, flipping in your IRA and paying the UBTI tax may still produce better returns for your IRA than other passive options. In your case, the $30K profit is reduced to just over $20K after taxes. That $20K net return still represents a 40% ROI to your IRA.

A lot of folks are scared of UBTI and would recommend being a hard money lender to remain passive and avoid the tax.  So you could lend money at perhaps 2 points and 12% interest?  I'll take the 40% thanks.

@Jeff Rabinowitz 

It has been common practice for many years for a loan applicant to list their retirement assets on a loan application.  For purposes of a lender evaluating the entire net worth of an individual, as well as their savings habit, this is fine.

Where you would have a problem with the IRS would be if you were to pledge those retirement assets as security for a personal loan. Simply listing the retirement assets on the application is not doing this, and the law is quite clear that an IRA or 401k is not subject to judgement in the event of a personal loan default.

@Account Closed 

There is not a simple answer to this question, as the "best" way will depend on the investors situation.  There are several self directed retirement plan formats they can choose from. So, the caveat to the following is that the investor should speak with an industry and/or tax professional.

An IRA or 401k can invest in real property, either to hold or to flip. The IRA account holder can direct the investments for a flip transaction, but cannot be personally involved as the contractor or personally receive any benefit from the transaction. The are essentially making the decisions, executing the contracts and handling the expense/income transactions exclusively for the benefit of their retirement plan.

When a tax exempt entity such as a retirement plan engages in a trade or business, and is therefore competing with taxpaying businesses, there is a trust tax known as UBTI that applies. The maximum rate can be as high as 39.6% on the gains from a transaction. A clear understanding of the impacts of this taxation is critical. The bottom line, however, is that even though there is the cost of this taxation when an IRA engages in flipping, the net, after-tax returns can still be superior to other investments an IRA might make.

An alternative is for the IRA investor to be the bank instead of the flipper. By providing capital to another party (who must be unrelated to the IRA account holder), and simply receiving interest on the loaned money, this becomes a passive investment transaction not subject to UBTI.

For some investors, it can make sense for the IRA or 401k to form a "blocker corporation". In this case, the retirement plan holds the ownership of a C Corporation that then engages in the flipping activities. The Corporation will pay tax on the gains from flipping, usually at a lower rate in the 25% range. The corporation can then issue dividends to the retirement plan and that income is tax-sheltered to the plan. This is a more sophisticated approach that will only benefit serious investors with the willingness to adhere to several layers of compliance, and comes with the additional administrative costs of the corporation, but it can result in significant tax savings.

@Albert Bui @Chris Martin 

It would appear that...

A) This will only impact new personal loans and not put limitations on any loans entered into on a non-recourse basis by an IRA or 401k.

B) This will not affect those investors using plans that offer checkbook control.

• A retirement investor using an IRA LLC would not have this issue. The IRA account statement would show the ownership of the LLC itself. The loans should be in the name of the LLC and using the LLC's tax ID - so off the radar for this type of underwriting.
• A retirement investor using a Checkbook Solo 401(k) would also be off the record, so to speak.  Typically, you create your own statement for such a plan as there is no institutional administrator.  Vesting would be in the name of the 401k trust, but the individual would be listed as the plan trustee.  Again, any note entered into by the plan would be using the plan's EIN, not the individuals SSN.  

It is still wrong, but the impact should be minimal for active investors seeking multiple Fannie/Freddy backed personal investment mortgages.

@Albert Bui 

That makes no sense whatsoever, and I would want to corroborate what you are saying.

You and your retirement plan are entirely separate, and per the tax code have to be treated that way. You cannot pay your IRA's loan payment with personal funds, nor can the IRA be used to pay your personal mortgage debts, so applying the balance of loans on one side of that ledger to the other for reasons of loan qualification is totally inappropriate.

When applying for a non-recourse loan for your IRA or 401k, the lender cannot even consider your personal financial well being, debt-to-income, or other factors. Sure, they can run a credit check to determine you are not a fraudster or serial bankruptcy artist, but you do not qualify for the loan. They are looking at the property and cash reserves in the retirement plan, period.

That's not to say that Fannie/Freddy might not be out in left field, but I'd want some confirmation that the way you heard this is in fact the case.

@Charlie Liu 

If you intend to farm the land, you absolutely cannot use 401k funds for the purchase.  Your business is a disqualified party to your plan.

@Account Closed 

One thought to add on this topic.  The Solo 401k is a great program and it sounds as if you qualify, so long term that is probably the better bet.  If you are looking to shelter 2014 income however, you will not be able to do that into a new Solo 401k.  The plan would have needed to be in place by 12/31/14 for that to happen.

But all is not lost. You can still establish a SEP IRA and make contributions for 2014. This can be done up until the tax filing date for your business. I'd recommend doing that with a mainstream bank or brokerage. Once you have made those contributions, you could then establish a Solo 401k and rollover the SEP funds then close that SEP account. The Solo 401k would then become your plan and provide you with the ability to self direct and have checkbook control over your retirement investing.

@Jeff Meachen 

You may be mis-interpreting what Doreen wrote. An IRA (or an IRA LLC) may obtain a non-recourse mortgage. Typically, you will need to have about 40% down and 10% in reserves, and a lender will only want to lend a minimum of $50k, so at about $90-95K this starts to work if you have at least $45-50K in the account.

North American Savings Bank and First Western Federal Savings are the two non-recourse lenders that operate in all 50 states.  Look them up.

Many of our clients use a non-recourse mortgage to leverage their IRA dollars and achieve a higher cash-on-cash return as a result.

There is taxation known as UDFI that applies on the portion of the income derived from the borrowed funds.  This is not typically a barrier to good returns, but does add complexity and you should seek professional guidance to learn more about this concept.

@Bob Lowry 

A self directed IRA or 401k can be a great means to diversify your retirement investing into real estate and related non-traditional assets.

The questions you ask are quite wide ranging, with answers that will be specific to your situation and investment goals. Random forum postings from general investors will probably not take you very far in improving your understanding of this topic as it pertains to you, and I would recommend you find one or more of the reputable self directed IRA advisory firms here on BP and give them a call.

Generally speaking, the IRA or 401k component of the plan stays the same with respect to contributions, distributions, etc. Self directing is just a means to invest differently - into assets not offered by the Wall Street firms. Of course, since this is tax sheltered retirement savings, the only goal is to deploy the capital into assets that provide the best mix of security and income potential. There can be no direct or indirect benefit between the use of plan funds and you or close family, family owned businesses, etc.

Best of luck as you embark on your education on this topic.  it can be pretty exciting when you find out how much control you can really have over your own retirement savings.

@Chuck VanDyne 

Clearly you have done phase 1 of your research. The thing to do now is speak with a professional who can go over in detail the specifics of your situation.

This is your father's IRA and will be in his name. Unless he is self employed, there is no option for the Solo 401k.

If you establish a checkbook IRA LLC, you can also be named as a co-manager of the LLC to help him invest. As a disqualified party, you will be pretty limited, and can really only offer guidance, networking and administrative help. You cannot benefit from the IRA - such as by receiving a commission on a real estate transaction for his plan. You are also prohibited from adding value to his plan through the provision of goods or services.

Either you or your father could handle the administrative acts of property management such as signing leases, paying the bills and receiving the income (all via the LLC, of course). You cannot perform maintenance or otherwise add value as indicated above.

With $20K in the account you would not be able to obtain commercial non-recourse loans from a bank. You could borrow from private lenders.  This introduces UDFI taxation on the profits associated with the borrowed funds.

Your father's IRA could JV with other investors on a property, which might be the best option.