David Moore of IRA Advantage examines whether you can manage a property owned by your self-directed IRA. He looks at property management versus property labor (and flipping) as well as what would trigger tax exposure on your account. Manage your investments wisely by understanding what you can and cannot do.
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Can I Be the Manager of Property Owned by My Self-Directed IRA?
Typically the answer to that question is yes, you can provide the administrative functions of management, but you shouldn’t go out and do what we call “getting dirty on the property.” In other words, sweat equity is not okay. You cannot go out and swing that hammer or paint that wall. Honestly, a lot of our clients are happy to hear that because they’ve been flipping properties throughout their lies, and for once, they have an excuse not to do it. When we look at managing an asset, yes, you can provide the administrative functions, but no, you canâ€™t do the dirty work to improve the property.
Of course, many people wonder how anyone would ever find out about that. Rest assured: It happens. You get audited. They look at the statements from that account, and they see the invoice to the paint company for $500 and then they ask where the money for labor is. That’s where the trap is. Do not do it. This is cautious money. This is money that you’ve put in there. You’ve worked hard to get your money into a self-directed IRA account. Don’t take chances with it. Take care of it, manage it, but don’t go out and work on those properties. This is a good excuse not to because you simply can’t.
A logical follow-up to this is whether you can make improvements to a property using IRA or 401(k) funds. The answer is yes. Once again, you shouldn’t be doing the work, but you can hire a contractor to do that work, and we have numerous clients who are going out and buying properties and improving them. That’s a great thing about real estate. You’re not waiting for a market to drive things up. You can create value by hiring a contractor, letting them oversee everything and get the project done, and that’s going to take care of you.
What If I Want to Flip Properties?
If you really want to be hands-on and flip properties and you want to be a real estate investor or create a real estate investment company, that’s a possibility. We’re just going to use a different structure. Instead of using an IRA or some combination of an IRA and limited liability company, we’re going to create what’s called a rollover business start-up, literally creating a new business that’s going to be owned by 401(k) plans. We’re going to move your money from whatever type of account it’s inâ€”as long as it’s an account that qualifies to be rolled into that 401(k) plan. We’re also going to create a C corporation for the 401(k) plan. The plan is going to buy the corp. We require our clients to be a shareholder of that corporation too.
The way it works is that the investment that the plan makes is in the corporation. It doesnâ€™t mean all the funds are going into that corporation. You still have a plan that’s going to allow you to make any investment if the law allows, but you’re going to use that chunk of money to buy into that corporation. You can literally be employed by a company that’s owned at least partially by your retirement account. It has to be a new company, but this is a possibility. Don’t look at a situation where you’re taking just that retirement account and working on that property.
When Are My Property Transactions Taxable?
If you look at the taxability of a transaction, a lot of times people will come in with a Roth IRA and say, “Look. I put all this money in there. I paid the tax. Everything I make with this account is going to be totally tax-free.” Well, that’s not true. If you have an investment that’s leveraged with an IRA, even Roth funds, you’re going to pay tax on an income or gain attributable to other people’s money, so it’s 50 percent loan-to-value. You’re going to have tax exposure on half of the income and half the gain on disposition.
Another situation that can trigger tax exposure is the fact that you’re conducting a business. Flipping property is not an investment. It’s a business. If you’re conducting business with that retirement account, you could be subject to what’s called unrelated taxable income. It’s not a reason to do or not to do something. It’s just something to be aware of. This is something you need to consult your tax people on to make sure that you’re taking care of that.
Making an investment is one thing and creating or conducting business is another, so it’s just a situation in which your account is subject to this taxâ€”not you personally. Work with your tax people to analyze that yield and factor that into your actual net income on the transaction. Make sure that it makes sense to you. If the investment makes sense with all things considered, then do it. And if it doesn’t, then don’t.
A lot is changing in the world of investing for retirement, and itâ€™s just too important to risk missing the details. The experts at IRA Advantage stay on top of every important development. Give them a call to get started today! 503-619-0223