I havent seen a thread in a while about IRAs.
I have an IRA and want to use it as part of the down payment on a rental property mortgage.
Before I call Entrust or another company, I just wanted to ask here first. Can I use my $40k IRA as part of a down payment and use cash as the rest?
No, you cannot mix your funds with your IRA funds. Your IRA is a trust fund created under the IRC (Internal Revenue Code). The IRC prohibits this trust fund from engaging in business transactions with you. You can direct the trust fund to invest as you want (whether it involves picking stocks or real estate investments), as long as the trust fund doesn’t invest with a prohibited individual (you, your spouse, your parents, your children, etc.).
There is a lot of hype about investing with IRA’s (the same rules apply to Roth IRA’s, HSA’s and some other trust-type savings plans under the IRC). The few self-directed IRA custodians promote IRA’s as great investment vehicles. What they fail to tell people about (and I’ve listened to their representatives speak several times) is Unrelated Business Taxable Income (UBTI). The IRC states that if an IRA invests using borrowed money, the percentage of the investment that is financed is subject to UBTI. For example, if you use $40,000 in an IRA to invest in a $100,000 property and borrow $60,000 to fund the investment, then 60% of the profits (whether income or cap gains) is subject to UBTI. UBTI is taxed at corporate tax rates. Yes, the 40% in equity is not taxed until it is withdrawn from the IRA (or not taxed at all if in a Roth IRA), but the 60% in leverage is first taxed at corporate tax rates and then taxed at personal income tax rates (if in an IRA) when it is withdrawn. Investing in real estate with an IRA doesn’t sound quite as sexy now, does it?
But wait, there’s more. If you are investing in real estate with an IRA, there is a good chance you won’t be able to borrow at as favorable a LTV as you would investing individually. Of course, one of the greatest benefits of real estate investing is using leverage. With an IRA, the power of leverage is decreased. You also don’t get the benefits of depreciation.
Before you take your IRA and invest in real estate, do your own analysis using FULL facts to compare the outcome of investing using an IRA vs. taking the tax hit up front by withdrawing from an IRA and using “normal” investing using 1031 exchanges. Put aside the promotional posture of self-directed IRA trust companies and the unconsidered and unanalyzed remarks of accountants and other professionals, and do your own analysis. Consider the differences between LTV and taxation (both initially and on the back end) in your analysis. Most other things will remain constant between the two investment approaches.
Depending on your investment goals, taking your money out of the IRA up front and taking the tax hit may have a multi-million dollar positive impact on your outcome. This isn’t to say IRA investments in real estate always have a worse outcome. Sometimes using an IRA is advisable, other times pulling money out of the IRA is advisable. The bottom line is there is not blanket answer and you need to do the analysis to decide which approach will provide you the best outcome.
Reed Peterson
Investor, Broker, Attorney, and LLM (Taxation) Candidate
Self directed IRAs are great for investing in REITs or real estate LPs with third parties. They are not good for investing in “your” company or joint ventures; rentals and other income producing properties present certain hassles as outlined above.
it can be disasterous if you “invest” in a prohibited transaction.
Reed,
I think UDFI is taxed at trust rates, not corporate rates. Trust rates are higher.
Also, I believe you can take depreciation in proportion to the debt-financed portion of the investment.