RE: Buying Property with a Self-Directed IRA: Issues Still unsolved at FastLane
Hi.
I have read all the threads in this topic (11 posts responded to search query ‘directed IRA’).
To summarize the sticky wickets (in two of the better threads:
I. This thread died at this issue: You cannot self deal.Specifically, the thread ended here “you may not have any ownership in the entity which is putting the funds to use.â€
http://www.thefastlanetomillions.com/asset-protection-taxes-legal/8511-self-directed-ira.html
II. This thread stopped here:
http://www.thefastlanetomillions.com/general-business-discussion/22397-self-directed-iras.html
One poster, JScott, has moved forward with establishing a C corporation.
JScott,
I am quite curious on what actually transpired on this item:
“7. You apply for special permission from the IRS for the C-Corp and 401k to have this ownership/control relationship (didn't really understand this part, but apparently it's just a form that needs to be submitted to the IRS)â€
Two BIG questions on my end:
A. If you have to ask IRS for permission, they can refuse. no? ‘Just “submitting a form†is a BIG difference from getting specialized exemption from following an IRS regulation! How exactly (and which form – specifically) provides the exemption for the ‘Prohibited Transaction’?
B. You, as the majority shareholder are in effect the controlling party of the IRA. So, what exactly are you doing to minimize ‘Unrelated Debt Finance Profits’.
At some point I must surmise the IRS will let enough folks on board the ship before they torpedo the ship with adverse ruling…
Will be interested to see over time if you think establishing the separate Ccorp and the requirements (management and reporting time) are worth it.
[yes, I do understand that you control the IRA (if done right) and the Corp within the IRA control the property].
[yes, I do understand that setting up a Corp within the IRA is a great idea to fund a business venture
But what I don’t understand is 1) Why you would use a Ccorp simply as a conduit to fund and manage property instead of another business venture more suited to Ccorp;
and 2) why not INSTEAD use a 72 T to de-fund the IRA and buy the RE Personally?
III. The five major drawbacks to purchasing RE in a self-directed IRA are summarized here:
Buying Property with a Self-Directed IRA
Pros:
- The IRA may provide your single largest source available funds to fund a down payment.
- You control the IRA (if done right), even if the IRA controls the property
Cons:
Q: Why is buying investment property (e.g a single family rental house) in an IRA a poor idea?
A: Answer: First, let’s review the goals for holding a rental house in the first place:
The Goals in Buying Real Estate (Why Buy RE):
1. Goal One: Cash Flow
On typical investment property the owner benefits because cash flow is offset by expenses and depreciation. These are taken as allowances (write-offs) on tax returns.
Drawback One: When you hold real estate within an IRA, you cannot claim deprecation.
Drawback Two: You hold real estate with capital gain, and then you die. What happens when you die? Then your spouse cannot use the capital gain rate, they must pay taxes on the step up in basis.
2. Goal Two: Appreciation
When selling a house with appreciation in a personal account long term capital gains rate apply if held for more than a year.
However, when selling a house with appreciation in an IRA the gains are taxed at ordinary income rates.
Furthermore, your transaction may qualify, in the opinion of the IRS, as a Unrelated Business Taxable Income.
Unrelated Business Taxable Income: When using leverage (debt financing) for a business property, including rental property, within an IRA, then the distributions of profit are at the business tax liability (capital gains is 15% but business tax is up to 35%).
In other words, when your IRA becomes a business, it is no longer personal money and you must then pay business tax rates on the gains.
More Drawbacks:
Drawback Three: If you buy a house using money in an IRA you will pay the 10% penalty. In my state, California, as in other states you will have to pay an additional penalty: 2% in my case.
Drawback Four:
Buying a house with an IRA requires non-recourse lending. You must sign a note and deed of trust/mortgage. The lender takes the house as collateral. Down the road, ff collaterals sells, but does not cover total of the loan, then the bank can come after you personally. This is exactly what got so many people in trouble in 2007 and 2008. They tried to sell homes where they owed more than the house was worth (they were ‘under water’). To make matters worse when the house did sell, and the bad loan was written off, the IRS considered this income and sent out a tax bill. With a recourse loan, the bank can only take the collateral.
Drawback Five:
You may purchase RE in an IRA, but if you use RE for non retirement purposes, the IRS will consider this a ‘self deal’ and may DISQUALIFY your ENTIRE IRA.
Q: Can you get a loan from your IRA for the down payment?
(That is, can you purchase leveraged RE - not just cash-only in full amount?). For instance could you roll IRA $ into a Ccorporation (or LLC)? Or could you use a 401k that invests in company stock; and then the individual gets a loan from the corporation?
A: NO, these examples are still self-dealing and therefore Prohibited Transactions.
Any time you use debt (get a loan) to purchase (debt-finance) RE in your IRA the IRS will treat this as Unrelated Debt Finance Profits, income which is taxable to the IRA first, and always taxed personally when it comes out of the IRA. In other words all profits attributed to the IRA will become taxable at personal income rates.
Q.. Can you buy investment property such as a strip building in an industrial park where your business is one of the tenants; thus keeping the IRA RE transaction at an arms length from your personal interest?
A: NO
You are still making an investment in something that helps you personally (it’s YOUR company), even if only partially.
IV. I have seen folks (DK) address issue TWO and partially address issues Five. Have not seen the other three fully addressed.
VI. Further, have not seen this alternate method of funding addressed:
Use a 72 T to de-fund the IRA and buy the RE with Personal money
We can discuss the mechanics of this strategy further later…
(Yet, without having the objections settled for the first CRE method:
A- holding RE within a corp; B- within self directed IRA; C- held by custodian. [i.e. three layers of bureaucracy]
I don’t see it yet worth comparing objections to 72-T withdrawal (e.g. one time RMD set up, able to be modified only once, etc.) at this point. That is, we should compare apples to apples and the IRA apples aren’t yet ripe).
Big topic, but worth carrying out to the natural conclusion, haven’t seen it done here (or anywhere else) yet.
Thanks for your input!
Hi.
I have read all the threads in this topic (11 posts responded to search query ‘directed IRA’).
To summarize the sticky wickets (in two of the better threads:
I. This thread died at this issue: You cannot self deal.Specifically, the thread ended here “you may not have any ownership in the entity which is putting the funds to use.â€
http://www.thefastlanetomillions.com/asset-protection-taxes-legal/8511-self-directed-ira.html
II. This thread stopped here:
http://www.thefastlanetomillions.com/general-business-discussion/22397-self-directed-iras.html
One poster, JScott, has moved forward with establishing a C corporation.
JScott,
I am quite curious on what actually transpired on this item:
“7. You apply for special permission from the IRS for the C-Corp and 401k to have this ownership/control relationship (didn't really understand this part, but apparently it's just a form that needs to be submitted to the IRS)â€
Two BIG questions on my end:
A. If you have to ask IRS for permission, they can refuse. no? ‘Just “submitting a form†is a BIG difference from getting specialized exemption from following an IRS regulation! How exactly (and which form – specifically) provides the exemption for the ‘Prohibited Transaction’?
B. You, as the majority shareholder are in effect the controlling party of the IRA. So, what exactly are you doing to minimize ‘Unrelated Debt Finance Profits’.
At some point I must surmise the IRS will let enough folks on board the ship before they torpedo the ship with adverse ruling…
Will be interested to see over time if you think establishing the separate Ccorp and the requirements (management and reporting time) are worth it.
[yes, I do understand that you control the IRA (if done right) and the Corp within the IRA control the property].
[yes, I do understand that setting up a Corp within the IRA is a great idea to fund a business venture
But what I don’t understand is 1) Why you would use a Ccorp simply as a conduit to fund and manage property instead of another business venture more suited to Ccorp;
and 2) why not INSTEAD use a 72 T to de-fund the IRA and buy the RE Personally?
III. The five major drawbacks to purchasing RE in a self-directed IRA are summarized here:
Buying Property with a Self-Directed IRA
Pros:
- The IRA may provide your single largest source available funds to fund a down payment.
- You control the IRA (if done right), even if the IRA controls the property
Cons:
Q: Why is buying investment property (e.g a single family rental house) in an IRA a poor idea?
A: Answer: First, let’s review the goals for holding a rental house in the first place:
The Goals in Buying Real Estate (Why Buy RE):
1. Goal One: Cash Flow
On typical investment property the owner benefits because cash flow is offset by expenses and depreciation. These are taken as allowances (write-offs) on tax returns.
Drawback One: When you hold real estate within an IRA, you cannot claim deprecation.
Drawback Two: You hold real estate with capital gain, and then you die. What happens when you die? Then your spouse cannot use the capital gain rate, they must pay taxes on the step up in basis.
2. Goal Two: Appreciation
When selling a house with appreciation in a personal account long term capital gains rate apply if held for more than a year.
However, when selling a house with appreciation in an IRA the gains are taxed at ordinary income rates.
Furthermore, your transaction may qualify, in the opinion of the IRS, as a Unrelated Business Taxable Income.
Unrelated Business Taxable Income: When using leverage (debt financing) for a business property, including rental property, within an IRA, then the distributions of profit are at the business tax liability (capital gains is 15% but business tax is up to 35%).
In other words, when your IRA becomes a business, it is no longer personal money and you must then pay business tax rates on the gains.
More Drawbacks:
Drawback Three: If you buy a house using money in an IRA you will pay the 10% penalty. In my state, California, as in other states you will have to pay an additional penalty: 2% in my case.
Drawback Four:
Buying a house with an IRA requires non-recourse lending. You must sign a note and deed of trust/mortgage. The lender takes the house as collateral. Down the road, ff collaterals sells, but does not cover total of the loan, then the bank can come after you personally. This is exactly what got so many people in trouble in 2007 and 2008. They tried to sell homes where they owed more than the house was worth (they were ‘under water’). To make matters worse when the house did sell, and the bad loan was written off, the IRS considered this income and sent out a tax bill. With a recourse loan, the bank can only take the collateral.
Drawback Five:
You may purchase RE in an IRA, but if you use RE for non retirement purposes, the IRS will consider this a ‘self deal’ and may DISQUALIFY your ENTIRE IRA.
Q: Can you get a loan from your IRA for the down payment?
(That is, can you purchase leveraged RE - not just cash-only in full amount?). For instance could you roll IRA $ into a Ccorporation (or LLC)? Or could you use a 401k that invests in company stock; and then the individual gets a loan from the corporation?
A: NO, these examples are still self-dealing and therefore Prohibited Transactions.
Any time you use debt (get a loan) to purchase (debt-finance) RE in your IRA the IRS will treat this as Unrelated Debt Finance Profits, income which is taxable to the IRA first, and always taxed personally when it comes out of the IRA. In other words all profits attributed to the IRA will become taxable at personal income rates.
Q.. Can you buy investment property such as a strip building in an industrial park where your business is one of the tenants; thus keeping the IRA RE transaction at an arms length from your personal interest?
A: NO
You are still making an investment in something that helps you personally (it’s YOUR company), even if only partially.
IV. I have seen folks (DK) address issue TWO and partially address issues Five. Have not seen the other three fully addressed.
VI. Further, have not seen this alternate method of funding addressed:
Use a 72 T to de-fund the IRA and buy the RE with Personal money
We can discuss the mechanics of this strategy further later…
(Yet, without having the objections settled for the first CRE method:
A- holding RE within a corp; B- within self directed IRA; C- held by custodian. [i.e. three layers of bureaucracy]
I don’t see it yet worth comparing objections to 72-T withdrawal (e.g. one time RMD set up, able to be modified only once, etc.) at this point. That is, we should compare apples to apples and the IRA apples aren’t yet ripe).
Big topic, but worth carrying out to the natural conclusion, haven’t seen it done here (or anywhere else) yet.
Thanks for your input!
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