Phase 2 - Real Estate 101 (How to or one big idea)

How Does Debt Impact A Self-Directed IRA Investment?

Tyler Stewert
August 24, 2021
How Does Debt Impact A Self-Directed IRA Investment?

Adam Hooper: There are other downsides to doing it through a self-directed account that you might not have in a taxable

Mat Sorensen: well, in a retirement account. One thing you got to look for is if there's debt involved. And so this is for IRAs. But any IRA or even HSA this is traditional or Roth, when it's investing in real estate, that's leveraged with debt.

There's a tax on profits from the debt. And it's called UDFI unrelated debt, finance income tax. So when I said earlier, if I bought a property for a hundred grand and I sold it for one 50, if my retirement account bought the property with cash, or I invested in a partnership, let's say an LLC with a bunch of other people and we didn't have debt on it.

We sell it for one 50. There's no tax on the gain. But if I brought debt into the deal, And let's say we, just so I can do the math, I'm going to keep it at a hundred thousand. I realize this may be a million or 10 million, but so let's just, I can do the math. Let's say it's a hundred thousand dollars purchase, but you put in 40 grand from your IRA or you and other Inbar partners and people in the deal.

Other investors essentially put in 40 grand to buy the property. And then you go get debt for the other 60,000. Let's say you then sell it for one 50. There's a $50,000 gain. And you get a write off in expenses. Of course it sell, but let's say it's a net $50,000 gain. The IRS looks at that and says 60% of this deal was dead.

It was not retirement plan dollars. It was not capital invested. It was debt. And we're going to tax the debt that leveraged the IRA's purchasing power. So if I, if their IRA. Put in 40 grand and got a loan for 60. They look at that as that 60,000 was not retirement account dollars. You don't get tax free treatment on profits from that.

So on a $50,000 gain, you have to take into account the debt that you put into it, which was 60% of the deal. So 60% of that, 50 grand. Would it be subject to this UDFI tax? So that would be, I think, 30,000 in that example, and then the UDFI tax on the, on a sell of a property is the capital gains rate. 20%, 20% of 30 grand is six.

So you'd end up the IRA. I should say, not you, the IRA would end up paying. Six grand on it. So that's probably the biggest downside is properties leveraged with debt that your IRA is investing. Now, despite that we have plenty of clients that invest in leveraged deals like that because the total return is better than the next best thing their retirement account can invest into.

If they say Matt, after that return, I can get on the deal. Even paying, a little bit of tax 20% capital gain, let's say on only the piece that's debt leveraged. I'm still ahead of the crappy mutual fund I've been in. We want to look at the net return at the end of the day, because the goal is to just get the biggest retirement account.

The larger account at the end of the day. So you just kinda gotta run the math, do the numbers, so to speak on what you think your total return is going to be. And that's when I think someone should look at using their retirement account to do this, it's not should I use personal dollars or retirement account dollars?

A lot of times people's personal dollars are frankly more tied up. Then there, then their retirement account dollars and they have a lot more leeway to use those retirement account dollars. So what I tell those clients is, and we're not financial advisors, but I just tell them just from a basics.

What else is your retirement account invest in? What's an invested in now or what's your next best investment you would make. If this real estate deal is a better deal, even if it's leveraged with debt and you gotta pay some UDFI tax from the IRA. Are you ahead of the game and if so, then that's an investment you should consider.

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