BUYING REAL ESTATE
WITH AN IRA AND A
NON-RECOURSE LOAN
BY: Mathew Sorensen, Partner
KYLER KOHLER OSTERMILLER & SORENSEN, LLP
3033 N. Central Avenue, Suite 415 | Phoenix, AZ 85012
Phone 602-761-9798 | www.sdirahandbook.com | www.kkoslawyers.com
Serving Clients Nationwide From Our Offices in Arizona, Utah, and California
BY: Roger St.Pierre, Sr. VP
FIRST WESTERN FEDERAL SAVINGS BANK
www.myiralender.com
Phone 800-908-8845
Disclaimer & About Mat
DISCLAIMER
All information and materials are for educational purposes only. All parties are strongly encouraged to consult with their attorneys, accountants, and real estate professionals before entering into any type of investment. This presentation does not constitute an attorney client relationship.
ABOUT MAT
Partner at KKOS Lawyers, assisting clients nationwide from offices in Arizona, California, and Utah.
Author of The Self Directed IRA Handbook: An Authoritative Guide for Self Directed Retirement Plan Investors and Their Advisors, an Amazon Best Seller and a textbook for the Retirement Industry Trust Association’s Self Directed IRA Professional Designation Course where I’m also an instructor. The Self Directed IRA Handbook is already the most widely used book in the self-directed IRA industry.
www.sdirahandbook.com
www.MyIRALender.com
First Western Federal Savings Bank, and its
employees are not accountants, nor are we
investment advisors, and we are not qualified to
provide advice on IRA rules, regulations or
eligibility requirements.
Please consult with your tax and investment
advisors.
What We’re Covering Today
1. How a SDIRA invests into real estate
2. Why you must use a “non-recourse loan”
3. Non-Recourse loan terms, options, and lending requirements
4. Property analysis by investor and lender
5. UDFI Tax Explained in detail
6. Pro’s and Con’s of buying real estate in an IRA with a non-recourse loan
Why The SDIRA Real Estate Market is Growing?
www.sdirahandbook.com
eData are estimated.Note: For definitions of plan categories, see Table 1 in “The U.S. Retirement Market, Fourth Quarter 2013.” Componentsmay not add to the total because of rounding.Sources: Investment Company Institute, Federal Reserve Board, Department of Labor, National Association of Government Defined Contribution Administrators, American Council of Life Insurers, and Internal Revenue Service Statistics of Income Division
Assets in individual retirement accounts (IRAs) totaled $6.5 trillion at the end of the fourth quarter of 2013, an increase of 5.3 percent from the end of the third quarter. Defined contribution (DC) plan assets rose 5.1 percent in the fourth quarter to $5.9 trillion. Government pension plans— including federal, state, and local government plans — held $5.6 trillion in assets as of the end of December, a 5.6 percent increase from the end of September. Private-sector defined benefit (DB) plans held $3.0 trillion in assets at the end of the fourth quarter of 2013, and annuity reserves outside of retirement accounts accounted for another $2.0 trillion.
In trillions
How Does a Self Directed IRA Invest?
-Need a custodian
(bank, credit union,
trust company) for the
IRA.
- Common investments
are real estate,
private companies,
LLCs, and precious
metals.
The IRA/LLC Structure Basics
SELF DIRECTED
IRAIRA/LLC
$$
$
Buys
Property
Receives Rent
Rather than a self-directed IRA taking ownership and buying an asset directly through
your Administrator/Custodian, the self-directed IRA purchases the ownership in the LLC
and the LLC takes ownership of the asset. In many instances, the IRA Owner manages
the LLC (subject to legal restrictions). This LLC can also use a non-recourse loan.
- IRA invests $ into LLC Bank Account
- IRA Owner, Manager of LLC, No comp (Ellis v. Commissioner, case)
- LLC acquires investment (e.g., property)
- Non-recourse loan funds a portion of the purchase price
- IRA owns LLC 100%, could be multiple IRA or parties owning different percentages
NON-RECOURSE
LOAN, BANK
LLC Pays Loan
Payments
Bank funds portion
of purchase
WHY MUST I USE A
“NON-RECOURSE” LOAN
EXTENSION OF CREDIT PROHIBITED TRANSACTIONS
IRC § 4975 (c)(1)(B) specifically states that a prohibited transaction occurs when there is a “lending of money or other extension of credit between a plan [IRA] and a disqualified person.”
RULES FOR OBTAINING A LOAN WITH YOUR IRA
1. If an IRA obtains a loan for its investments the loan must be “non-recourse” to the IRA and the IRA owner (e.g., lender’s only recourse is against asset). The IRA owners cannot personally guarantee the loan. Peek & Fleck v. Commissioner.
2. UDFI Tax due on net income from debt. Profits attributable to retirement plan cash or other non-debt investment is not subject to UDFI tax. (more later on this). Applies to IRAs, 401ks other employed based plans are exempt from UDFI tax.
www.MyIRALender.com
Loan Options1-4 Family Residential
60% LT60% LTV in most states
25 Year Financing Available
3/1 ARM @ 4.25%
5/1 ARM @ 4.875%
10/1 ARM @ 5.5%
20 Year Fixed Rate Available
6.25%
www.MyIRALender.com
5 Units Plus/Commercial Properties
and Vacation Properties50% LTV
3/1 ARM @ 5.25%
5/1 ARM @ 5.875%
10/1 ARM @ 6.5%
Fixed Rate @ 7.25%
Index is the 1 Year T-Bill
Rate Caps are 2% annually and 6% lifetime on our 3 and 5 year ARMs
No Pre-Payment Penalty on any loan
www.MyIRALender.com
Fees
1% Origination Fee
$300 Processing and $300 Underwriting fee
Appraisals are required on every loan request, ordered by us in
the market where the property is located.
Our fees are the same for Refinances or Purchase Money Loans
You will have normal and customary closing costs in the
market where your property is located.
www.MyIRALender.com
Timing-How long does it take to close?
It costs Nothing to Apply and we normally can get you a loan
decision in 2 days if we have a complete application.
Then, counting appraisals, title insurance, and other
processing it takes about 30 days to close.
So, start to finish, about 30-32 days from Ap to Close.
www.MyIRALender.com
4 Main Issues
1. Does the IRA have the funds?
40-50% down
Closing costs
15% of loan amount minimum reserves
2. Debt Service Coverage 1.25 or greater
3. Is the property a good one?
4. Does the transaction make sense?
www.MyIRALender.com
Debt Service Coverage Ratio
Purchase Price $100,000 Residential Single Family Home
Loan Amount $60,000
Gross Rental Income $12,000 ($1000/month)
Less Vacancy (7%) $840
Taxes $1400
Insurance $600
Maintenance $600
HOA $0
Utilities $0
Mgmt. (10%) $1200
Net Operating Income $7360
Annual Debt Service $3900 (25 years @ 4.25%)
DSCR $7360/$3900=1.89
www.MyIRALender.com
Debt Service Coverage Ratio
Purchase Price $184,000 Residential Home with HOA
Loan Amount $92,000
Gross Rental Income $15,600 ($1300/month)
Less Vacancy (7%) $1092
Taxes $2200
Insurance 500
Maintenance $1000
HOA $1500
Utilities $0
Mgmt. (10%) $0
Net Operating Income $9308
Annual Debt Service $6373 (25 years @ 4.875%)
DSCR $9308/$6373=1.46
www.MyIRALender.com
Debt Service Coverage Ratio
Purchase Price $600,000 Commercial Building
Loan Amount $300,000
Gross Rental Income $60,000 ($5000/month NNN)
Less Vacancy (7%) $4200
Taxes $0 Due to Tenant paying taxes
Insurance $0 Due to Tenant paying insurance
Maintenance $3600 (Owner pays for large items)
HOA $0
Utilities $0 Tenant pays
Mgmt. (8%) $4800
Net Operating Income $47,400
Annual Debt Service $30,136 (15 years @ 5.875%)
DSCR $47,400/$30,136=1.57
www.MyIRALender.com
Look Under the Covers(Do your due diligence)
•HOA’s-Get 2 years Financial Statements and a Budget
•Crime-Research local crime statistics for this area
•Condition-Must be nearly rent ready (Max $10K in
rehab needed for us to close a loan on a given property).
• Age of property-Less than 75 years old or inspection
required.
www.MyIRALender.com
Issues that can derail a loan
•Over-estimating rental income, especially vacation properties (do your due diligence!)
•Buying the most expensive property in the
neighborhood
•High Crime areas
•Poor Condition of the Property
•Global Debt Service Coverage Weak
•Reserves inadequate
www.MyIRALender.com
Entities Acceptable for Non Recourse Loans
• Any Self Directed IRA
• LLC’s made up of single or multi-member IRA’s
• Self Directed 401K’s or LLC’s made up of 401K Members
www.MyIRALender.com
6 Reasons to Tap Retirement Funds Now to Buy Real Estate
1. Tangible Asset - you can see, touch, and feel
2. Real Asset Diversification
3. Many Choices in today’s marketplace
4. Affordable Prices
5. Better Cash Flow
6. Upside Capital Appreciation
www.MyIRALender.com
Properties We Lend On
Residential (single family, multi-family, apartments)
Commercial
Farms with income (rental income or CRP income)
Unrelated Debt Financed Income Tax
Unrelated debt financed income (“UDFI) tax applies to the gains received by an IRA that are attributable to debt. IRC § 514. UDFI tax is applied to income from “debt financed property” that is subject to “acquisition indebtedness.” Rate is capital gain rate on income from sale of an asset and is UBIT rate (39.6% on other income such as rental).
CALCULATING & REPORTING UDFI TAX
To calculate UDFI tax, you need to know the following three numbers:
1. The income from the property for the year. 2. The average acquisition indebtedness for the year. 3. The adjusted basis for the year (e.g., the cost of the property minus any depreciation).
UBIT/UDFI Rate
$0.00-$2,500 15% $0.00 $2,500-5,800 $375 + 25% of amount over $2,500$5,800-8,900 $1,200 + 28% of amount over 5,800 $8,900-12,150 $2,068 + 33% of amount over 8,900 $12,150 or greater, 3,140.50 + 39.6% of amount over $12,150
UDFI Rate at Sale is Long-Term Capital Gains Rate, 20%
UDFI Tax Basic Example
For example, let’s consider a property purchased by an IRA for $100,000 and sold over a year later for $130,000. The property was purchased with $40,000 from the IRA and $60,000 from a loan. Let’s assume the remaining average debt was $50,000 at the time of sale, and that deductions for the year were $5,000. Based on this scenario, UDFI tax would be calculated as follows:
1. $50,000 avg. debt/$100,000 basis = 50% leverage2. Gain of $30,000 from sale of $130,0003. 50% of $30,000 = $15,0004. $5,000 of deductions against $15,000 = $10,0005. Therefore $10,000 would be subject to the 20% long-term capital gains tax rate. Tax owed would be 20% of $10,000 = $2,000.
- The tax rate on the sale of property is the capital gains rate. Note the UBIT/UDFI rate on other year to year income (e.g. rental).
UDFI Tax: Advanced Example
Rental Property Advanced UDFI Tax Example: Purchase Details
Purchase Price: $195,000
Closing Costs: $5,000
Total: $200,000
IRA Funds Invested: $80,000
Non-Recourse Loan: $120,000
25 yr. loan at 5% ($700/mo. payment)
Leverage Ratio: 60%
UDFI Tax: Advanced Example
YEAR 1 AS A RENTAL
IncomeAnnual Rental Income: $19,200 ($1,600/mo.)
ExpensesProperty Mgmt Fees: $2,000Repairs/Maint: $1,500Insurance: $600Property Taxes: 800Mortgage Interest: $5,944Total: $10,844Depreciation: $6,970 (27.5 yr./residential)Total with Depreciation: $17,814
Cash-Flow: $8,356
Apply Leverage Ratio of 60% to Income and Expenses
Income: $11,500Expenses: $10,700$800 UDFI Income
$1,000 automatic deduction allowed
End Result = 0 UDFI/UBIT Tax Due, even with $8,356 in cash-flow
UDFI Tax: Advanced Example
YEAR 1 AS A RENTAL
Final Number Breakdown
Net Cash-Flow: $8,356
UDFI Net Taxable Income: $800, minus $1,000 automatic deduction, 0
UDIF Tax: 0
Effective Tax Rate on UDFI Income: 0
UDFI Tax Cost: 0
UDFI Tax: Advanced Example
OWN THE PROPERTY 10 YEARS & THEN SELL
Sales Price: $300,000Expenses/Closing Costs: $20,000 (broker and title/escrow)
Loan Balance At Time of Sale: $73,000 (from amortization sched, 25 yr., 10 yrs int, plus an additional loan pay-down of $11,000)
Cash Return From Sale: $280,000, less $84,285 loan re-pay, less $80,000 IRA invested, cash gain of = $115,715
Adjusted Basis: $137,000 ($63,000 in depreciation over 10 years)
Total Gain: $163,000
Leverage Ratio: 54%UDFI Income: $88,020UDFI Expense: $10,800Net UDFI: $77,220UDFI Tax Rate at Time of Sale: 20%UDFI Tax Due: $15,444
Benefits of Leverage
Return Over 10 Years
IRA Cash Invested: $80,000
Annual Cash-Flow: $7,938 ($8,356, reduced by 5% for vacancy estimate)
10 Years Annual Cash-Flow: $79,380 (assumes no increase in rent)
Gains From Sale: $115,715
Total Cash Returns: $195,095
UDFI Tax Paid: $15,444
Account Value at the End: $80,000 (started with)
$195,095 (10 years rental income cash flow, andgains from sale.)
-$15,444, UDFI tax paid on saleNet Gain after paying UDFI :$179,651
Account Value After 10 Years of Investment
$259,651
990 Return FAQs
Q: What are the filing deadlines for a 990-T for IRAs? A: April 15th, 3 month extension available
Q: Who Pays the Tax? A: Your IRA pays the tax.
Q: Who files the 990-T? Does my IRA custodian do this for me? IRA owner’s responsivity. A: Your custodian does not file this for you.
Q: If I have losses can I carry those forward to offset a later gain when I sell? A: Yes, if you have losses over 3 years you must file the 990 to capture those losses so they can be carried forward to later off-set a gain.
Q: What are typical fees to prepare a 990-T? A: Our law firm prepares 990-T’s and charges between $250 and $750 depending on complexity (assumes you have a set of Quickbooks and bookkeeping completed).
Benefits of Leverage
PROS
I need the leveraged funds (loan) to acquire a specific property.
I’d rather use leveraged funds and buy two properties rather than all my cash and buy one.
I’d rather invest my other retirement plan cash in something else and use the leveraged funds to invest in
other assets.
CONS
Interest
UDFI Tax
QUESTIONS
You’ve got questions, we’ve got answers.
This webinar will be recorded and posted next week
on www.sdirahandbook.com along with the slides.
BY: Mathew Sorensen, Partner
KYLER KOHLER OSTERMILLER & SORENSEN, LLP
3033 N. Central Avenue, Suite 415 | Phoenix, AZ 85012
Phone 602-761-9798 | www.sdirahandbook.com | www.kkoslawyers.com
Serving Clients Nationwide From Our Offices in Arizona, Utah, and California
THANKS
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