Self-Directed IRAs Hold Several Advantages For Multifamily and Commercial Real Estate Investors
This week, I sat down with The Entrust Group’s Mindy Gayer to discuss self-directed IRAs (SDIRAs), with a particular focus on how multifamily investors can utilize them to reduce their overall tax burden. In this comprehensive interview, we discuss subjects including:
- What self-directed IRAs are and how they work
- Why real estate (particularly multifamily) is one of the most popular types of alternative assets investors place in SDIRAs
- How to roll over funds from traditional IRAs and other retirement plans (like a 403(b) plan) into a SDIRA
- How an SDIRA can take out a non-recourse loan to purchase multifamily or commercial real estate
- How investors can partner their SDIRA funds with personal funds, other people’s SDIRA funds, or with others’ personal funds to make larger investments
- Forming an IRA LLC vs. custodian control
- 1031 exchanges, Opportunity Funds, and SDIRAs
Hi, Mindy, thank you so much for taking the time to speak with me today. To start, could you please tell us a little bit about yourself and your experience?
I am the Southeast Region Business Development Manager for The Entrust Group. I’ve been with the company for a little over two years; my background is in the retirement space, and it’s something I’m very passionate about. Before working for Entrust, I actually worked at AIG on the retirement side.
For as long as I’ve worked in the retirement space, I didn’t even know that people could self-direct their IRA until right before I started working for The Entrust Group. In fact, 97% of Americans don’t know that they can self-direct their retirement account.
Self-directed IRAs have been around since 1975, but for some reason, the traditional market has monopolized the retirement industry. We’re known as educators in the industry, so we like to help people clear up any misconceptions or questions they might have about self-directed IRAs.
What can you tell us about your company?
My company, The Entrust Group, has been in the industry for thirty-eight years. We are record keepers and custodians for self-directed IRAS; essentially, we hold alternative assets for our clients. We currently have approximately 22,000 clients and hold about $3.4 billion in assets. It’s important for readers to realize that we don’t provide legal advice, tax advice or investment advice; we’re strictly record-keepers and custodians providing education about self-directed IRAs.
What is a self-directed IRA? Why do investors choose this type of IRA?
A self-directed IRA has the same characteristics as a regular IRA, but you’re able to self-direct, which means you’re able to choose what type of investments you put in it. There are three main investments you cannot place in a self-directed IRA; life insurance, collectibles, and shares of s-corporations. However, the spectrum of things you can invest in is very broad; for instance, you can invest in REITs, in precious metals, and in tax liens; we even had a gentleman years ago who invested in a racehorse.
In essence, you’re your own fiduciary and you are selecting the assets you want to invest in inside your retirement account; this gives you more control and allows you to invest in assets where you fully understand the potential risk and return associated with the asset.
There is a pretty big misconception in regards to self-directed IRAs. If you go to your current IRA custodian and ask about investing in alternative assets, they will typically tell you one of two things; either that you can’t do it, or that you can but you have to pay the penalty if not of retirement age and pay the taxes (except for ROTHs) and then use the funds out of your IRA to invest the money yourself.
In general, standard IRA custodians don’t provide the services in order for you to self-direct your IRAs (SDIRAs). Investors will typically need to find a custodian who specializes in alternative assets outside of the traditional market and move their money over to that custodian. It’s just like moving your money from Charles Schwab to Fidelity; it’s not a taxable event (as Entrust is also a custodian/record-keeper).
Like you just mentioned, self-directed IRAs allow an investor to invest in alternative assets like limited partnerships, LLCs, gold, real estate, and more. How do multifamily investments stack up compared to some of these other options?
Real estate is actually our biggest area of business in regards to SDIRAs and has been for a long time. People are investing in the areas they know, which often includes multifamily and commercial real estate. They do this either by directly investing in a multifamily or commercial property or by investing in real estate syndications or real estate funds.
How does someone’s level of income impact whether a self-directed IRA is a good choice for them? I.e., are they only a good idea for investors above a certain income level?
That all depends. As a general rule, you should seek investment and tax advice based on your current scenario; SDIRAs are really best for individuals who know all the potential risks and returns of everything that they’re investing in.
Can investors rollover/transfer funds from a qualified account into a self-directed IRA? If so, how?
Yes. Investors can move money from one or more IRAs (traditional to traditional or Roth to Roth or conversion of traditional to Roth) into a SDIRA via a transfer or rollover. Investors are only allowed one “60 day rollover” from an IRA to another IRA per 12 months. They can also move partial funds from a traditional IRA into a SDIRA. Additionally, investors can rollover their old 401(k), 403(b), or 457 money into a SDIRA, as long as it’s an old one and you’re not still employed with the company who sponsored it. If you want to roll over a plan sponsored by your employer, you should check with your current plan administrator. You usually have to wait until you’re no longer with the company, but this isn’t always the case.
Can you form an LLC using IRA assets as a funding source? If so, how does this work?
Yes, you can. There are actually four ways to buy assets inside your IRA. You can purchase directly, which means the administrator buys your asset in their name for your benefit. As an investor, you can also actually partner with anyone at the initiation of the purchase, even a disqualified person. You can also partner with yourself; for instance, if you wanted to buy a property for $100,000, you could use $50,000 in a SDIRA, and another $50,000 in personal funds (or $50,000 in funds from a friend or family member) to do so. However, to do this, all earnings and expenses must be split 50/50 in this instance, (or whatever percentage of ownership you establish at the initiation of the purchase – based on each partners contribution amount). The portion of ownership of the IRA must pay expenses from IRA account. You are not allowed to commingle your IRAs expenses with your own money, and vice versa.
Let’s go over an example of a situation that would be prohibited: if you had $100,000 in your SDIRA and you bought 100% of a property with your IRA money, then, a year later, you decided you wanted to make $30,000 of renovations on the property, and you or your spouse had the cash, you couldn’t partner after the fact because your IRA owns the property 100% and doing business with a disqualified person after the initiation of the purchase is prohibited.
Who is a disqualified person? You, your spouse, your lineal ascendants and descendants (parents, grandparents, great grandparents, children, grandchildren, great grandchildren, etc.), your beneficiaries, and anyone who manages your money. Entities where you are 50% or more owner are all disqualified. However, other family members such as siblings, aunts, uncles, nieces, nephews, are not disqualified from partnering at any time (unless they are also a beneficiary).
You can also use leverage to purchase multifamily or commercial real estate via an IRA; specifically, your IRA can take out a non-recourse loan. However, doing this may result in you needing to pay UDFI (Unrelated Debt Financing Tax). As we don’t offer tax advice, it’s always important to reach out to a tax advisor before taking out a loan with your IRA.
Finally, you can create a new LLC, in which your IRA is a member of the LLC. All the same partnering rules apply, but an LLC gives you checkbook control. However, you need to understand the rules and regulations if you want to do this as there's a much higher chance that you’ll get audited. In short, if you want to take this route you need to keep very good records, and you need to understand what you can and can't do. Additionally, you should keep in mind that you could be exposed to UBIT (Unrelated Business Income Tax).
Can you go over the prohibited transaction rules for self-directed IRAs? Could you mention one or more situations in which these could apply to multifamily investors?
Like I just mentioned, your IRA cannot do business with a disqualified person; this means that you cannot do business with your financial advisor, financial manager, your IRA account custodian, certain family members, your beneficiaries, and any entity where you have 50% or more ownership.
However, there are grey areas; for instance, in some situations, you can invest in an entity where you have 49% or less ownership. If you’re interested in doing this, then you should dive a bit more deeply into IRS code 4975, which speaks further on prohibited transactions. For instance, you can’t have any discretionary authority over the entity; in most cases, this means you can’t be an officer of the company. Perhaps you could be an officer, but one without discretionary authority. In most cases, however, you can be a manager or another highly compensated employee. There are so many ways to structure these types of transactions, so you should always seek professional tax and legal advice.
Can a SDIRA hold funds from an Opportunity Fund?
In my opinion, it doesn’t necessarily make sense for SDIRAs to invest in Opportunity Funds, as there’s already a tax benefit to investing in an IRA. In addition, a lot of Opportunity Funds may be S-corporations, which means that SDIRAs can’t invest in them.
What should investors know about 1031 exchanges and SDIRAs?
Generally speaking, the 1031 exchange and capital gains doesn’t exist when you’re purchasing real estate inside a SDIRA as it’s already inside a tax sheltered account, so you don’t have to go through the 1031 exchange process. However, if you’re interested in fixing and flipping properties (particularly if you want to do more than one in the same year), you should probably consult a CPA.
I understand that traditional IRA contributions are tax-deductible in the year they are made, while Roth IRAs withdrawals in retirement are not taxed. Is this true? And is it better to have a self-directed traditional IRA or a self-directed Roth IRA?
That’s true, but there’s more to it, and it depends on your current situation. You have until the tax deadline of the following year to make contributions for the previous year (that is if you are eligible to make contributions). The money that goes into a traditional IRA is tax deferred, meaning you haven’t paid the taxes on it and will pay those taxes once you start taking withdrawals from the account. You’ll pay taxes on those withdrawals based on the tax bracket you are currently in the year of the distribution. In contrast, traditional IRAs grow tax deferred. Contributions into a Roth IRA have already been taxed, so your Roth IRA grows tax free-- and once you start taking distributions you will not be paying taxes (since you already have). However, Roth IRAs have income limits, so you will want to check with your CPA to ensure you are eligible to contribute to a Roth.
It’s also important to realize that you can begin taking IRA distributions at the age of 59 ½ without penalty. You must take distributions (known as required minimum distributions, or RMDs) from traditional IRAs once you reach 70 ½. There are no RMDs with a Roth account. When determining which type of IRA could be right for you, it’s best to seek advice from your CPA. The point you want to consider is: do you want to pay taxes in the tax bracket you’re currently in (Roth) or do you want to pay taxes in the tax bracket you’re in once you start taking distributions (traditional).
Like you mentioned, contributions to traditional IRAs are also tax-deductible in the year you make them or up until tax deadline of the following year, which is a huge benefit for investors. Investors should also know that you can convert a traditional IRA to a Roth IRA at any point, but you can’t convert a Roth IRA to a traditional IRA. As with everything else we’ve discussed, you should always talk to your CPA or tax advisor before making any big decisions involving your IRA.
What do SDIRA services cost for investors?
Fees vary, but in regards to The Entrust Group, our fees are middle of the road for the industry. We generally charge $299 a year per asset as a record-keeping fee. Whether this is a lot of money is relative to the value of your asset; it could be a lot for an asset worth $10,000, but might not be much for an asset worth $100,000. There are also smaller transaction fees for buying or selling assets, as well as a fee to establish the account. We also offer a value-based percentage fee structure, which makes sense for people with a smaller amount of assets or multiple smaller assets.
In addition, we offer reduced fee structures for investment sponsor companies. For instance, for groups of six or more multifamily investors, we would offer a group discount.
Thank you again for taking the time to speak with us today and share your valuable knowledge. How can our readers get in touch with you?
You can give me a call at (615) 900-4015 or send me an email at [email protected].