When it comes to purchasing self-directed IRA investments, are you allowed to combine personal and plan money? It IS possible to add funds within your annual contribution limits, in the event the real property or other investment assets requires additional funds… However, with that said, it is important that investments in real estate using qualified funds are done conservatively with suitable reserves. David Moore covers all the details on this week’s look at combining these funds for your investing.
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Hello, David Moore with equity advantage in IRA advantage, iraadvantage.com. I just want to hit something real quick with the market being the way it is, the pressure on it, the lack of vendor, the urgency of acquisition, maybe the additional down payment that’s required to get a deal done, we’re in more and more our clients are wanting to combine irons along with personal funds to make an acquisition happen.
I just want to put out there when I look at an exchange, if you’ve watched my videos, you’ve heard me say it before, I ‘m going to break it into four basic components, and it’s got to be an exchange. What’s going to receive must be of like kind. We need to for total deferral, go across ruin value and equity. I want to stress it’s 1031, not all or nothing though, so don’t worry about spending every dollar you have to if the perfect property is less than what is needed for total deferral. That’s okay, you’re just going to pay tax on the difference. So, I say every dollar you spend more than you want, costs you a buck if you don’t spend it’s maybe 30 or 40 cents.
So one, it’s got to be an exchange. Two, what’s going to receive for like kind. Three, we satisfy, what we call the napkin test which says the costs are up in value and equity. Finally, we have to have continuity vesting the person or entity that gives us something has to be given something back. If, I look to retirement accounts, I’m looking at two primary issues, what does the person want to buy and who are they transacting between for the benefit of?
So, when I talk about what’s able to be purchased with a retirement account, you can buy with an IRA, literally anything other than collectibles, life insurance contracts or stock in a sub-S corporation. If we’re looking at 401K plan, the only thing I can buy is collectibles period – one thing. So, rarely is the investment of problem what triggers problems for people with retirement accounts, it is that second factor transactions between them for the benefit of the disqualified party.
So, who’s a disqualified party, well, your lineal senate’s descendants, their spouses or any legal entity owned in controlling interest by one of those. Note, I didn’t mention siblings, siblings are not disqualified parties nor ran uncles, cousins. You can’t transact between them for the benefit of this qualified party, but this is very, very important, you can transact along with a disqualified party. So, if you’ve watched our videos on the Equity Advantage channel, you’ve probably heard me say that the combination of qualified money or 401k funds and 1031 funds is going to require tenancy and common ownership structure, which is true.
If we’re putting a 1031 together and you want to add funds via or retirement account, that retirement account is going to be an additional purchaser of the property, it’s not you, it’s not your money, so it’s going to be a tenancy in common ownership, because 1031 specifically prohibits the exchange of partnership interest, which a membership interest in LLC would be. So, we need to use the tenancy in common structure, not because it’s an IRA, but because we’re using 1031 money to get into it. So, we need to make sure we’re taking care of that. But when we’re combining those funds, I want to stress, once again, it’s not a prohibited transaction to transact and combined personal money and plan money into a common investment, but if we’re using a 1031, it’s going to require tenancy in common structure.
If we’re not using 1031 money, we can use either tenancy in common or we can use a new limited liability to have both your retirement account or technically speaking, the trust company for benefit of your IRA along with you as members of that thing.
Now, if we fund a multi-member LLC with two disqualified members, we can fund it. The initial funding is fine, but we cannot have additional money coming in from any disqualified source in the future, so we need to over-fund that funding of the LC and that’s one of the reasons they like the tenancy in common structure, if you’re using a TIC.
You need to have an IRA specific tenancy in common agreement though. Number one, you can’t just have a TAC agreement. Number two, the provisions in that agreement needs to be specifically spelled out to be in compliance with IRAS or 401k plans. I just want to bring that up because it’s coming up more and more and more.
Another item you need to think of when you’re looking at financing, if you’ve got financing involved with that acquisition, two things you have to be aware of, one, with an IRA, even with a Roth IRA, if there’s income or gain attributable to other people’s money, which a loan is other people’s money, if you have buy a property, 50% loan to value using an IRA, you’re going to have tax exposure on half the income and half the gain on disposition.
If it’s debt free, then you’re not going to have it, and I want to stress even with the Roth IRA you’re going to have tax exposure. If you have a leverage investment, if you’ve got a loan on it, you’re making money off other people’s money, you will have tax exposure on the income or gain attributable to other people’s money. This is not a problem, just factor that into your return on investment it’s going to be there.
The reason I bring up lending our loans in this video is that if we’re going to combine personal money and plan money, a new common investment, it has to be non-recourse debt, what that means is it’s got to be an IR 401k compliant loan. Ultimately, that you if you’re the IRA owner that loan’s not going to be subject to you your credit or your income. You are not on the hook for that loan.
If you’re on the hook for it, it’s recourse to you, therefore it’s to prohibited transaction to get it done. Any loan that specifically for an IRA, a 401k, the only recourse, the bank has in a default is to take that asset period.
Now you say, Well, gee, it’s non-recourse to my IRA I’m just going to have a recourse to me on my piece of this asset. It doesn’t matter the loan was made because you’re in there, so it doesn’t matter if it’s non-recourse in the IRA piece and recourse to you on your personal piece. That doesn’t work, it’s got to be totally non-recourse and you’re going to have to deal with a bank, a lender that’s going to work without it.
Typically, if you work with a credit union in their first comment might be, oh yeah, we can take care of that. They’re not going to be able take care of it, at least I’ve never met one that we got a deal done with. It is for a variety of reasons, but number two, you’re going to have to work with either a regional bank that understands this stuff or a bank that’s set up specifically to make that type of loan. If you’ve got questions or concerns on that, get a hold of us.
The main point of this video is I want you to understand, you can go out and buy a property using personal money and plan money in a common investment. It’s got to be structured. It’s got to be done right. Don’t come to us at the 11th hour when you’re closing tomorrow, trying to get it done, we need to take the time to plan it out correctly to make sure we’re getting where you want to go.
If there’s anything I’ve learned over the dozen years we’ve been handling retirement account transactions is that people are conservative with their retirement accounts and rightfully so, and we need to make sure that we’re doing things correctly from the onset of the deal, don’t try to throw it together, it’s not worth it. The cost of a prohibited transaction with an IRA is full distribution of all funds in the account as of the first day in the year in which the indiscretion of occurred. So, you don’t want to screw up 401k plans. Much, much better situation, and they prohibit a transaction, only money involved with the discretion.
These are all reasons you want to have a great team of people. You’ve heard me say before, tax people are critical, they’re the ones that are going to be sitting there with you day in, day out, and don’t use them come April 15, talk to them before years end and look at what’s going on. If you sold the property, want to pay the tax, you got other things out there, if you’ve got a transaction is triggering some tax exposure, look at what else you’ve got in your life that can offset the games with the losses, they’re so on and so forth, but give your tax people some time to deal with what’s coming up.
I hope you found this helpful today, I hope the season finds you healthy and happy with you all test this holiday season, and I look forward to working with you next year and good riddance 2021. Looking forward to 2022 and all the bright that’s ahead of us. So, thank you for the time today and I look forward to working with you in the future.
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