All Forum Posts by: Brian Eastman

@Stan Butler 

Think of your question differently and it might come to you. Why would you put stocks in an IRA when you can hold real estate instead?

The tax circumstances between an IRA and personal funds are very different. The goal for the IRA is to invest in the safest possible asset with the potential for solid, consistent returns. Real estate and notes fit that bill nicely.

@Timothy Riley 

It sounds as if you are trying to build the LLC yourself. That would likely be a mistake and could result in at best a lot of frustration with a custodian not being willing to accept non-compliant LLC documents or at worse a prohibited transaction if the LLC is not structured properly. There are several professional firms that specialize in this service and provide high quality education (not SDIRA Custodians, but advisory firms). The tool (IRA LLC) is one thing. The knowledge to properly use the tool is the key. As you note, even your sage mentor is in the dark on this specialized topic.

You could not have an IRA hold a unit of a personal series LLC, if that is what you are asking. In fact, we do not recommend a series LLC in most situations as there is not any sufficient case law to prove the isolation of cells will hold, and in most states there is no cost difference between a series LLC with 2 cells and 2 separate LLC entities.

There are many exit strategies.  You can continue to hold property and draw off the income, distribute the property in-kind or sell the property and allocate the cash differently - reinvest, distribute partially, etc.  

@FRANK R. 

Firstly, while you and your CPA are correct that an IRA does not benefit from deductions on earnings, it does not pay taxes on income in the first place.

Comparing real estate held within an IRA to real estate held personally is like those proverbial apples and oranges. You should be comparing how your IRA performs when invested in real estate with how the IRA performs invested in other assets such as the stock market.

The ONLY way you can ever take ownership of the properties is to have the properties appraised and then take the properties as a taxable distribution.  That tax bill will be significantly larger than a lifetime of the deductions you will then get on the property you would now own personally.

While your IRA could sell the properties to someone who is not a disqualified party (including your brother), you could not then purchase those properties personally. That would be an indirect transaction between the plan and a disqualified party (you) - and is just as prohibited as a direct transaction.  

If you really miss the write offs and cannot stand holding property in your IRA, sell the properties to an unrelated 3rd party and have the IRA carry a note instead. You'll get a good return, with a solid asset underpinning your investment, and you won' t be missing out on any deductions.

@Brandon Powell 

That would absolutely be a prohibited transaction in the eyes of the IRS.

By providing the loan to the buyers via your 401k, you are facilitating the sale of the property.  This clearly provides a benefit to you and your wife, both of whom are disqualified to the 401k.

Who setup your Solo 401(k)?  Do they not provide guidance for these types of questions?  They should.

@Kelley B. 

The IRA LLC is generally vastly superior to tying to run a rental property through a 3rd party custodian.

The key to success with such a tool is understanding the rules. That comes with education and not all providers of IRA LLC platforms focus much energy on that concept.

Yes, there are limitations to putting IRA money to work in property. The thing to keep in mind, however, is not how owning a rental in your IRA compares to owning a rental personally, but rather how holding rental property compares to other options you have for your IRA such as the stock market.

I'll take the occasional hassle of an eviction over drastic market corrections any day!

The temptation is to want to do everything yourself as a means to reduce cost. While you certainly can do most of the administrative acts of property management yourself with an IRA LLC, sometimes leveraging the expertise of a professional property manager can pay huge dividends in terms of the performance of your properties. Quality tenants are the number one way to make rental real estate profitable.

@Kelley B. 

The eviction will work pretty much just like any other, according to state and local law.

Is the IRA holding the property directly via the custodian, or via an IRA LLC?

Either way, the IRA is the property owner/landlord.

You should hire an attorney to execute the procedure. If you were to do this yourself, you run the risk of being viewed as adding value to the IRA through the provision of services. While it is OK for you in some senses to administer the investments of the IRA, an eviction process is an additional level of involvement and time that should be hired out.

@Tom States 

Dimitri is correct. I would chip in by stating that there is absolutely 100% no way you can salvage this transaction with IRA funds in your name. Any workaround that you may possibly come up will result in a prohibited transaction. The fact that you are currently on title in your own name makes this property toxic poison to your IRA.

Time to start working on a different exit strategy and see if you can find a way to dish this property off to another investor.

Sorry.

@Jesse T. 

But what is the point of that kind of transaction?  Why would you borrow money just to park it?  If you put the $25K to work, the gains on those investments will be taxed to you personally.  

I'm not saying that a 401k loan is a bad thing in all cases, but you want to be very sure you will get your principal back along with enough earnings so that, after-tax, those earnings are significant enough to justify the risk of the investment.

Generally speaking, you are better off just investing the 401k directly into a performing asset at arm's length.

The bottom line from our firm's perspective is that we want our investor clients to seriously consider the financial implications of a 401k loan before using that tool.  So many folks in the self directed industry and frankly on Wall Street too promote that 401k loan as "easy money", which it is not.  

The only reason congress implemented the 401k loan was because they knew people would be more likely to commit to setting money aside for their future retirement if they had an escape valve. (I know, congress and logical thinking are hard to image, but that was way back in 1974).

@Jesse T. 

No, both the principal and interest are impacted.  You are losing the initial tax deferral value of your original plan contributions.  

You put $25K into the plan pre-tax.  So, it only took you $25K of earnings to get there.  There are no taxes or penalties for borrowing the $25K.  In order to re-pay the note, however, you are now using your own personal after-tax dollars.  If you are in the 28% tax bracket, that means you need to earn $35K in order to have $25K of after-tax money to put into the plan to repay the borrowed principal.

@Steven W. & @Dawn Anastasi 

Real estate income that is passive in nature is 100% sheltered within the IRA. Taxes only apply when you take a distribution from the IRA (unless it is Roth). This would include income from rents, interest on hard money loans and the like. Real estate activities considered engaging in a trade or business activity such as flipping, wholesaling or new construction/development are subject to Unrelated Business Taxable Income. This is a trust tax paid by the IRA on the gains from such business activities,

This exposure to taxation is not necessarily a reason to avoid such transactions. If you can flip a house, pay the tax and still walk away with greater than 20% ROI to the IRA, that is likely better return than you would get with rentals or hard money lending. If you intend to engage in such activities, you want to be sure to work with an IRA provider that is very knowledgeable on the topic and have a CPA on board as well. There are many "document providers" who cannot help you fully understand this concept and lack of knowledge equals risk.

@Jesse T. 401k loans are a poor approach to real estate investing. Some people heavily promote that idea because it sounds good (aka marketing candy), but they are masking an ugly truth about the high cost of such an approach.  There are two key problems with this approach. 1) You are removing the capital from the plan and have the opportunity cost that goes with that. Sure, the plan will receive about 4-5% income from you on the note, but most investors can do better than that.  2) The cost of the money is much higher than it appears.  The reason for this is that you put the funds into the plan on a tax-deferred basis.  You will repay the loan with after-tax funds from your pocket.  If you are in the 28% tax bracket, that means you need to earn $35K to pay off a $25K loan from your 401k.  Hard money is much less expensive.

@Nick Weidner 

Whether a lender will be OK with the down payment coming from a 401(k)  will depend largely on their overall underwriting.  I do not believe there is a state law component, but there could be, so check with your lender.

A lot of folks here on BP tout the idea of a 401(K) loan for a property purchase.  The thing that is missed by most is the fact that the $25K loan will likely cost you in about $35K.  Is that worth it to you?

The issue is that while you do not pay taxes or penalties on the borrowed funds, you are replacing the pre-tax dollars in the plan with after-tax dollars out of your pocket.  In addition to the interest on the loan (which does go to the plan), you are effectively paying whatever your marginal tax rate is on top.  So, if your tax rate is 28%, that $25K will cost you $35K in new earnings to replace.

My firm markets Solo 401K plans that offer a participant loan. Some of our investors choose to use that loan provision.  But, we are always sure to point out this key fact about the true cost of that money. It is the right thing to do.