Investing in Real Estate Rental Properties through a Self Directed IRA

Investing in Real Estate Rental Properties through a Self Directed IRA

The similarities between purchasing a real estate rental property personally (with “after tax” funds) is very similar to purchasing property through a self directed IRA. Consider some of these key factors:

Ownership

To avoid personal liability issues, investors often set up a limited partnership (LP) or a limited liability company (LLC) that owns title to the property.  It is important to note however that a self directed IRA may not own real estate via an S-Corp.  For LPs and LLCs, the self directed IRA owns the entity with checkbook control. The title to the investment property and all related transaction documentation should be held in the name of the LP or LLC entity, which are signed and executed by the entity manager.

Administration

Expenses for the investment property typically go through the LP or LLC entity’s bank account, as are rental payments (whether cash, checks or wire transfers).  It is important to note that in no event should the self directed IRA account owner receive money or pay expenses through his or her personal checking or savings accounts.

Co-Investment

It is our view that the simplest way to invest in real estate through your self directed IRA is to finance the entire investment through your own account, without involving outside parties (especially family members). “Keep it simple.” Of course, should a self directed IRA investor not have all the funds needed, it should take special care to avoid any prohibited transaction with a disqualified person such as a spouse, parent in law, son or daughter in law, direct ancestor (eg, parent) or descendant (child). In other words and practically speaking, find a sibling, friend and work acquaintance to co-invest with.

Debt Financing

Borrowing money to fund a self directed IRA investment is an option, but has its potential drawbacks. First, any loan for a self directed IRA real estate investment must be non-recourse. There can be no pledging of collateral for the loan (either IRA accounts or personally) or any personal guarantees, both of which are prohibited by the IRS. Since the non-recourse loan supporting a self directed IRA investment lacks typical “credit support” in the form of pledged collateral and personal guarantees, the cost of a non-recourse loans is typically more expensive. Finally, an obscure IRS rule imposes a tax on income a self directed IRA generates using debt financing. Thus, if a self directed IRA investor uses 50% of his or her own funds and borrows the remaining 50%, the “debt financed” portion of any rental income and gains from the appreciation fo the property will be taxed and subject to Unrelated Business Income Tax (or UBTI).

For 2015, a Self-Directed IRA LLC subject to UBTI is taxed as follows:

UBTI                                                      Tax

Up to $2,500                                      15% of UBTI

Between $2,501 and $5,900         $375, plus 25% of UBTI in excess of $2500

Between $5,901 and $9,050         $1,225, plus 28% of UBTI in excess of $5,900

Between $9,051 and $12,300        $2,107, plus 33% of UBTI in excess of $9,050

Over $12,300                                     $3,180, plus 39.6% of UBTI in excess of $12,300

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