Self-Directed IRA regulations

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ray.james
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Self-Directed IRA regulations

Post by ray.james »

I am looking for guidance if this would constitute self-dealing and thereby run into issues with IRS. The case in question pertains to a friend who have been in this country for 10+ years and along with spouse have size-able 401K/IRA money that is available to roll over. However he had low savings outside of that. They do have 3 rental in his home country which are cash flow positive( but 2 have mortgage ). Would using the money from SD-IRA to acquire one's own rental constitute self-dealing?

This sounds same as selling stocks in taxable and buying in retirement accounts. Post that, would using the new cash-flow to buy a home constitute self-dealing? The mortgages on the rentals will be paid off and the rentals will held in ira as they yield 12%; until retirement.
When in doubt, http://www.bogleheads.org/forum/viewtopic.php?f=1&t=79939
Alan S.
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Re: Self-Directed IRA regulations

Post by Alan S. »

ray.james wrote: Tue Jul 31, 2018 2:05 pm I am looking for guidance if this would constitute self-dealing and thereby run into issues with IRS. The case in question pertains to a friend who have been in this country for 10+ years and along with spouse have size-able 401K/IRA money that is available to roll over. However he had low savings outside of that. They do have 3 rental in his home country which are cash flow positive( but 2 have mortgage ). Would using the money from SD-IRA to acquire one's own rental constitute self-dealing?

This sounds same as selling stocks in taxable and buying in retirement accounts. Post that, would using the new cash-flow to buy a home constitute self-dealing? The mortgages on the rentals will be paid off and the rentals will held in ira as they yield 12%; until retirement.
Yes, the purchase of your own property by your IRA is obvious self dealing, a prohibited transaction. This includes property owned by other disqualified persons such as a spouse or lineal descendent. Your self directed IRA custodian is a good source for information since they deal with prohibited transaction rules and the IRS interpretation of them on a daily basis.
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jimb_fromATL
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A few more points to ponder

Post by jimb_fromATL »

This article at bankrate.com discusses: Why real estate investing in a self-directed IRA makes no sense

Another article at Kiplinger's about the pitfalls of self directed IRAS.

Here are some links to FAQs from the IRS about “prohibited transactions” and other problems with real estate and other investments within self-directed IRAs:

https://www.irs.gov/retirement-plans/re ... ments-faqs

https://www.irs.gov/retirement-plans/pl ... ansactions

Just some things to think about, gathered from other discussions:
  • You cannot manage or maintain it yourself or have a family member do it. You cannot put in “sweat equity” to fix it up to flip it for profit or to rent it out. You cannot use it for yourself or buy it from or sell it to a family member.

    You have to pay a “custodian” to manage your investment for you. That alone would eat up a lot of any potential gain. In fact IMO about the only people who even suggest that you invest in individual parcels of real estate within self-directed IRAs are the people who make their money by managing your property for you, since you’re not allowed to do anything with it for yourself.

    The rules are so complicated that there are a lot of mistakes made, even by the pros. And because it is so misunderstood there is an awful lot of misleading information and outright fraud. Then if you or your custodian make a mistake in the complicated rules about "arms-length" and prohibited transactions, the IRS will probably count it as a premature withdrawal with taxes and the early withdrawal penalty.

    Even in the best case of finding an honest and competent custodian to manage it for you, then you would essentially lose all of the tax breaks and advantages that are normally associated with real-estate investing for property that is outside of retirement accounts.

    Among other problems, you lose the advantage of leveraging, since no lender is likely to be willing to give your IRA a mortgage at a viable rate, and you cannot personally guarantee it.

    Within an IRA you cannot deduct any expenses like property taxes, insurance, maintenance and repairs, advertising, travel expenses, management fees, or the depreciation allowance. All those are things can make real estate investing profitable outside of retirement accounts, but are of no benefit within an IRA.

    You also lose the opportunity to use any losses (either real or “paper” losses) to offset other income for tax purposes. Any profit it might make is also reduced by the extra fees you must pay the custodian and maintenance and repair folks, since you’re not allowed to do anything with it for yourself.

    Then when you sell it you pay regular income tax on the gain in your highest bracket when you withdraw it from your IRA, instead of the lower long term capital gains tax rate.
I don't know for sure, but here's something else that comes to mind for further research:
  • It occurs to me that in a tax deferred IRA you might also run into problems with RMDs (Required Minimum Distributions) after age 70½. (Although as I understand it, there may be a way to sell off partial shares of the property within the IRA to yourself to meet the RMD requirement, but it seems to me it would awfully complicated to have partial ownership in a property that you're not allowed to manage by yourself because of the arm's length rule.)
Even if RMDs are not an issue and/or you have enough other funds in your IRA(s) to meet the RMD requirement while you're alive, your heirs will eventually have to pay regular income tax on the sale of the home when they inherit your IRA ... and it will be on all the gain in value since you bought the property.

(If they inherit a home from you outside a 401(k) their cost basis becomes its market value at the time of your death, so they could sell it at current FMV with no tax at all.)

Plus you if you decide you don't want to keep an investment property outside an IRA, you can defer taxes on the gain virtually forever by doing a 1031 exchange for another investment property that might be more conveniently located.

You can also get some equity out of a normal investment property with taxes still deferred by borrowing against its equity. Not so if it's in your IRA.

jimb
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ray.james
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Re: Self-Directed IRA regulations

Post by ray.james »

Alan S. wrote: Tue Jul 31, 2018 2:20 pm
ray.james wrote: Tue Jul 31, 2018 2:05 pm I am looking for guidance if this would constitute self-dealing and thereby run into issues with IRS. The case in question pertains to a friend who have been in this country for 10+ years and along with spouse have size-able 401K/IRA money that is available to roll over. However he had low savings outside of that. They do have 3 rental in his home country which are cash flow positive( but 2 have mortgage ). Would using the money from SD-IRA to acquire one's own rental constitute self-dealing?

This sounds same as selling stocks in taxable and buying in retirement accounts. Post that, would using the new cash-flow to buy a home constitute self-dealing? The mortgages on the rentals will be paid off and the rentals will held in ira as they yield 12%; until retirement.
Yes, the purchase of your own property by your IRA is obvious self dealing, a prohibited transaction. This includes property owned by other disqualified persons such as a spouse or lineal descendent. Your self directed IRA custodian is a good source for information since they deal with prohibited transaction rules and the IRS interpretation of them on a daily basis.
Ah! that's what the name implied. I had a hope considering stocks can be exchanged that way.
I guess for Self-directed rules have to strict to avoid misuse.
When in doubt, http://www.bogleheads.org/forum/viewtopic.php?f=1&t=79939
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ray.james
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Re: A few more points to ponder

Post by ray.james »

jimb_fromATL wrote: Tue Jul 31, 2018 3:02 pm
[/list]

I don't know for sure, but here's something else that comes to mind for further research:
  • It occurs to me that in a tax deferred IRA you might also run into problems with RMDs (Required Minimum Distributions) after age 70½. (Although as I understand it, there may be a way to sell off partial shares of the property within the IRA to yourself to meet the RMD requirement, but it seems to me it would awfully complicated to have partial ownership in a property that you're not allowed to manage by yourself because of the arm's length rule.)
Even if RMDs are not an issue and/or you have enough other funds in your IRA(s) to meet the RMD requirement while you're alive, your heirs will eventually have to pay regular income tax on the sale of the home when they inherit your IRA ... and it will be on all the gain in value since you bought the property.

(If they inherit a home from you outside a 401(k) their cost basis becomes its market value at the time of your death, so they could sell it at current FMV with no tax at all.)

Plus you if you decide you don't want to keep an investment property outside an IRA, you can defer taxes on the gain virtually forever by doing a 1031 exchange for another investment property that might be more conveniently located.

You can also get some equity out of a normal investment property with taxes still deferred by borrowing against its equity. Not so if it's in your IRA.

jimb
Thank you jimB. That was extremely useful info. I think we can make this a sticky post for others that come along asking about self-directed IRA. I read 2-3 articles but none had even 10% the info you posted which is pertinent to decision making.

Reading the rules and the conditions, it seems self directed IRA is useless for almost all investment. It seems more pain then us even in corner cases. The only situation it might work is if one is a gold bug and want to hold physical gold.
When in doubt, http://www.bogleheads.org/forum/viewtopic.php?f=1&t=79939
Venturahandyman
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Re: Self-Directed IRA regulations

Post by Venturahandyman »

As a novice to this forum but not so much to investing options, all the rules previously stated are of concern but I feel can be managed. I've engaged in rentals with a small portion of my retirement.
The SDIRA can work well for rental properties in good condition, desirable areas, and where property values appreciate. I'm probably off center on my thoughts, but I'm willing to lose the depreciation as I plan to keep my rentals rotating out ~10 years.
Currently we have one residential rental in a SD but planning for others, the other three are non SDIRA rentals.
I welcome and would sincerely appreciate anyone's feedback on my investment plan.

What turns my stomach about stock investments is when someone in Hollywood states they are not using social media anymore and my stock drops 3%, somethings wrong.... When my VMGRX and VDADX portfolios lose 14% I cringe. Currently my portfolio is 60 equities, 30 real estate (non reit), 10 liquid. 6% ROI on RE. 3%/3% inc/app. I'm sure I'm missing something but this is how I've managed it. Feedback welcome. My sincere apologies for getting off topic.

My SDIRA feedback:
Study (understand if even possible) all the rules from the IRS website.
Look at all aspects of the prospective rental properties expenses and income. (Pay for the best property inspector for the inspection prior to closing).
Pay close attention to the property market you are considering investing in.
Understand the cost associated with potential repairs and the impact to your ROI.
Develop a "network" of knowledgeable repair staff you trust to work on your properties. (Minimize cost)
Carefully calculate for RMD's to ensure a portion of your retirement portfolio (other equities) can be liquidated when necessary.
Search out similar investors with similar skill sets where you can collaborate to meet the "rules of engagement".
Arms length is the rule, but I feel it can be managed.
My next SDIRA consideration is small parcels of farm land within close proximity to desirable rural areas.
At the appropriate time, consider the move from the real estate SDIRA back into a traditional IRA via a transfer.

For over 20 years I've considered an SDIRA using rollover funds from my first employer, now that I retired (55), I've got to be deligent the $'s last. With any luck, they will.

Best of luck.

As I said above, I'd appreciate others feedback and apologize if my response doesn't meet the spirit of this forum.
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