401k to IRA to self directed LLC real estate investing - LS1TECH - Camaro and Firebird Forum Discussion



401k to IRA to self directed LLC real estate investing

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Old 08-27-2013, 07:10 AM   #1
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Default 401k to IRA to self directed LLC real estate investing

I want to see if anyone has advice/direction/experience in using IRA to invest.

I bought my current house as a short sale 3 years ago in shithole yet live able by bank standards condition, gutted it floor to ceiling wall to wall and invested 20k making it modern and nice. Similar houses are now going for 250 and I paid 150. I enjoyed doing the work and want to start flipping houses on the side. I went to the Than Merrill CT home builders class and although overall it was just a sales pitch and a waste of time and money, they did turn me on to the idea of moving your 401k to a self directed IRA, starting an LLC, and using that to start flipping houses. You can move your 401k to an IRA to an investment TAX FREE, which is what I am about to do.

My friend does IRAs for Fidelity and can move my money for free, but he does not believe his company can give me a self directed LLC or how to move it to real estate. Has anyone done this or work in IRAs or know any good places to get info on this? I'm going to talk to my bank and mortgage company Wells Fargo and see if they are any help.

401ks grow so slowly, and seeing as how I made 70k flipping this house in 3 years, that's way more than my 401k has grown. I know it can be risky, but I'm only 27 and no kids so I want to start now. I make well over 100k a year already with decent credit, so I shouldn't have an issue getting approved for another mortgage. My plan is to use my 401k to buy a short sale or foreclosure, pull out 50k of my equity in my current house, use 20 to renovate the new house in 2 months, add 80-100k of value, put 20k in the bank with direct deposit on the new mortgage incase it takes a while to sell the current house after I move into the new house, and 10k as backup. Then sell the old house, take the new equity out of the new house, and use that money to invest again. I think I can turn 50-80k in profit in 6 months assuming 2 months renovation and 4 months to sell the old house.

Thoughts?
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Old 08-27-2013, 09:13 AM   #2
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Using your retirement funds to flip houses, what could possibly go wrong?

401K's growth rate is determined on what your investment direction is. If you feel it's growing too slowly, then you need to embrace more risk. For instance if you were 100% invested in the S&P 500, the 3 year average return is almost 18%. Compounded that's $6K on $10K in principle. Or if your 401K balance was 100K, you made $60K+. With a lot less work and risk then in real estate. It is hard to compare returns of your real estate foray vs. your 401K without knowing the principle you had invested in each. It's impressive to say I made 70K in 3 years flipping houses. But less impressive when a 100K balance in your 401 would've returned the same with the right asset mix and not a drop of sweat.

Let's do the actual math and compare. You sold for 250K. You invested 170K of your own money in this. 150K for the house. 20K for materials. X dollars in property taxes, closing costs, and eventual sales tax when you sell. So you said you netted 70K in profit (which yes, is a taxable capital gain). OK. Also subract out the quantifiable amount of your personal time spent doing the work. Now consider this. If you had instead invested that 170K in a basic S&P fund in Aug'10, with dividends reinvested you would have a total return of 64.48%, or 110K. (from http://dqydj.net/sp-500-return-calculator/). Having done little more than a few keyboard strokes, you would've made 40K more than your house flipping. And in an asset (equities) that are less risky/volatile than real estate.

Real estate is experiencing growth again right now. But research how many flippers lost their shirts in '07 when the housing market began a 3 year rapid decline. Are you certain it won't do that again? Particularly as interest rates have increased rapidly in the past 3 months, and will continue to do so as QE3 is phased out? Your whole business plan is banking on continuing appreciation of housing prices, and recent history has proven that is far from guaranteed.

Now to your specific question, it's a bit out of my realm but I kind of doubt the feasibility of what you propose in buying real estate with the 401K funds. 401K's are typically funded with pre-tax income. Outside of the few exceptions for qualified withdrawals, you can't pull money out of it without paying a 20% penalty plus associate income tax. Yes, you can roll it over to an IRA but the restrictions still apply - penalty plus income tax for early withdrawal. There is an exception for 1st time home purchase, which is maybe what the sweet talkers are trying to confuse you with, but not for ongoing real estate investments. I also do not believe your employer will allow you to roll out of their 401K while you are still (I presume) employed with them.
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Old 08-27-2013, 09:24 AM   #3
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Here's one website I found.

http://www.irafinancialgroup.com/structure-maryland.php

The 401k I'm going to invest is what was left over fully vested when I left my last company 8 months ago, it's currently just sitting in their hands without any new money being put in as I never rolled it over to my new company. You can invest 401k into an IRA into real estate tax free, you are essentially just making different types of investments with it, as long as you put the money and profit back into the IRA. If you cash out, yes you pay taxes, at least that's how far my understanding goes.

As far as the 70k in taxable gain, if you reinvest in real estate within 1 year you don't have to pay taxes on it. If you cash out, taxes. There were also tons of people who lost their shirts in the stock market in 07, not just real estate. The first time home buyer thing is one that I need to get a solid answer on, as almost every flip website seems to think that as long as you put the 401k into a self directed IRA for an LLC, you can use it to make investments, whether real estate, gold, money lending, whatever.

I made 70k in 3 years because I lived in it and living in a house while flipping it while working 60 hour weeks blows. I'd become unmotivated and it took forever for me to finish ****. Hell I still never finished painting the trim in the guest rooms. If I could have gone to the house, worked on it, then gone home to a hot shower and a clean bed, it would have been done much faster. Like gutting the kitchen and boiling noodles on the grill for a week sucks. Or not showering for 4 days while I redo all the plumbing in the bathroom sucked. Instead of 70k in 3 years I could do 70k in 3 months, there's not much else to compete with that.

Last edited by bufmatmuslepants; 08-27-2013 at 09:41 AM.
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Old 08-27-2013, 12:39 PM   #4
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So I'm not too familiar with them but I did just a few minutes of research. I'd suggest you do the same quite a bit more extensively, as everything I come across makes it look quite murky, and if you screw up the IRS is going to come collecting. In fact maybe try the board at seekingalpha or another financial resource, because you're getting beyond the typical retirement planning scope. Don't just take the sales pitch of these custodian firms. They remind me of Amway promising riches from being your own boss, when the whole thing is a scheme for someone else to get rich.

Real quick though, here's some things I found:

http://www.businessweek.com/news/201...f-directed-ira

Particularly notable:
Quote:
Tax twists

Self-directed IRAs are complex legal structures that, if managed incorrectly, can lead to stiff penalties from the Internal Revenue Service. The primary mistake is any appearance of self-dealing, where you benefit financially or otherwise from the property in the account before the minimum distribution age of 59 1/2. That means if your IRA owns real estate, you or any immediate family members can’t live in it or get any rental income from it directly. Otherwise, you could invalidate the status of your IRA account and be subject to a 10 percent tax penalty for the account’s value.

Moreover, all repairs, management and property tax costs must be paid with the IRA’s funds. So you must either have a buffer in the account to pay for unforeseen expenses, or hope that the annual maximum allowable IRA contribution, currently $5,000, will cover costs. You can’t even make repairs by yourself without your own “sweat equity” being considered a contribution to the account. Desich recommends that investors keep 5 percent to 10 percent of their property’s value in liquid securities such as cash or bonds to cover future repairs.


Nor can investors employ a traditional mortgage to finance IRA properties. An IRA account doesn't allow its owner to be held personally liable for any unpaid debt. The only permissible loans are so-called non-recourse loans that use the property itself as collateral. These have higher interest rates than conventional mortgages, and any income earned with the portion of the property owned with this leverage is considered outside the IRA and fully taxable. “Such loans aren't always easy to find,” says Bromma. The rates he sees range from 5 percent to 7 percent. As a result, most self-directed IRA real estate deals tend to be all-cash.
Also one other point in response to your post. While true many people lost a lot in the market collapse from '08 and '09, when you lose money in mutual funds all your burden is looking at lost dollars on paper. Doing so with real estate means now not only did you lose funds, but you're stuck with a tangible asset which incurs ongoing costs from taxes and maintenance. My 401K lost over 60% in the bear market - and 4 years later made it all back and much more by doing not a thing beyond adding recurring contributions. Were I stuck with a house bought in '06 at the peak, 7 years later there's a good chance I'd barely be back to my initial investment while it continually sucked dollars (and time/effort) away each month.
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Old 08-27-2013, 01:47 PM   #5
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Originally Posted by NHRATA01 View Post
Self-directed IRAs are complex legal structures that, if managed incorrectly, can lead to stiff penalties from the Internal Revenue Service. The primary mistake is any appearance of self-dealing, where you benefit financially or otherwise from the property in the account before the minimum distribution age of 59 1/2. That means if your IRA owns real estate, you or any immediate family members canít live in it or get any rental income from it directly. Otherwise, you could invalidate the status of your IRA account and be subject to a 10 percent tax penalty for the accountís value.
Would not a strict reading of this also include the profit from the sale of the house, or is that exempt. Theoretically do you have to have the property in until 59 1/2. Just something to consider.
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Old 08-27-2013, 03:25 PM   #6
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Would not a strict reading of this also include the profit from the sale of the house, or is that exempt. Theoretically do you have to have the property in until 59 1/2. Just something to consider.
I don't think so, profit from the sale would be considered a capital gain, just as if you held an individual stock and it appreciated (or any of the other "exotic" investments, like commodities, that the self-directed IRA allows). One interesting thing I did read though is that since you must take RMD's (required minimum distributions) at 59.5, if you have it all tied up in real estate you'll need to sell the physical asset to liquidate the amount, or face more IRS penalties for not taking your RMD. I don't think the OP has to worry about that for awhile though...
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Old 08-27-2013, 07:41 PM   #7
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Agree with NHRATA. This is a terrible idea.

By all means do an IRA if you want, but don't pull your money out to flip houses. Pulling out your home equity is an even worse idea.

If you have ADDITIONAL capital outside of your retirement contributions that you can play with and you want to try your hand at flipping houses, then by all means go for it.

But you should have some more conservative investments to fall back on in case it doesn't work out.

Quote:
Originally Posted by bufmatmuslepants
I'm only 27
You should read up on compound interest and understand why pulling your money out of your retirement accounts now will mean severely depleted earnings later in life, even if you start putting away a lot more in retirement later on.

Let me give an example.

Joe is 27, he starts putting away $150 a month, he does so for 40 years until he retires at 67. If he's able to earn 8% in the market he will have $503k when he retires.

Bob is 37, he waits 10 years longer than Joe to start saving so he decides he needs to catch up, and he puts away double what Joe does ($300 a month). If he also retires at 67, he will only have $440k earning the same percentage.

Even though Joe put away only half what Bob did for virtually his entire life, he still ends up with more because he started 10 years earlier.

Last edited by infinitebird; 08-27-2013 at 07:58 PM.
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Old 08-27-2013, 08:40 PM   #8
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I understand what you are saying infinitebird, I have a business minor and remember the compound interest stuff. My biggest thing is that I am confident I can make 25k minimum per flip, even if Im literally just buying short sales and foreclosures, powerwashing everything, painting, cleaning, and then reselling as normal sales. The only reason I want to use the equity in my house is that I dont believe in 2 months the market will crash enough for the house to drop 20% in value to below what I owe (I would barrow up to 80%)

I spoke with Wells Fargo, and he agreed with you guys above that moving the money to an IRA and then investing with that can cause huge issues with taxes if I dont do it PERFECTLY. He recommended just barrowing from my 401k and using the equity in my house. My only issue with barrowing is that I can only use half, which is not enough for a downpayment and closing costs on a 240k house unless I can get some lender to use my wife as a first time home buyer and let me use that status, since I bought my house before we were married and she has never been on a deed. Wells Fargo doesnt do this, but he said some other lenders do.

One thing I need to figure out that I thought of is, say I used 30k of IRA money to buy a 300k house, and financed the rest, so 10% is IRA money. If I turn around and sell the house for 400k, would all 100k profit have to go back into IRA in order to not pay taxes, or just the original 30 plus 10k for the 1/3 ROI? If thats the case, then Id be able to use the remaining 60k profit and move on to another house, without barrowing from IRA this time.

Last edited by bufmatmuslepants; 08-27-2013 at 08:48 PM.
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Old 08-27-2013, 09:08 PM   #9
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First of all, it's borrow, not barrow.

Secondly, and I mean no offense by this, but all the stuff you threw out in that post (not having enough for closing costs, using your wife on the loan, wondering about the tax burden) says to me that you really do not have enough money to spare trying this out. My guess is you will regret it if you do.

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Originally Posted by bufmatmuslepants
One thing I need to figure out that I thought of is, say I used 30k of IRA money to buy a 300k house, and financed the rest, so 10% is IRA money. If I turn around and sell the house for 400k, would all 100k profit have to go back into IRA in order to not pay taxes, or just the original 30 plus 10k for the 1/3 ROI?
What you have to pay back to avoid a high tax burden usually depends on what kind of IRA it is and how much of what you take out is original contributions vs growth generated.

I actually considered trying this myself a while back, but in the end I realized it was just too risky without a greater margin for loss.

Last edited by infinitebird; 08-27-2013 at 09:17 PM.
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Old 08-28-2013, 07:12 AM   #10
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The only reason I want to use the equity in my house is that I dont believe in 2 months the market will crash enough for the house to drop 20% in value to below what I owe (I would barrow up to 80%)
I'm not trying to rain on the parade, but that's exactly what happened in the last housing crash. I put a townhome on the market for $315K in early '08 that I bought in '04 for 230K and owed 160K on the note. In July of '08 I was set to go to contract at 290K and the buyer backed out. By March of '09 when I sold, I let it go at 250K. The house basically lost 65K in value over the course of a year. In the fairly stable NY metro market which was hardly as volatile as some of the hot/cold areas like Vegas, Florida, Cali, etc. So you're being overly optimistic if you think you're going to be able to quickly unload a house that couldn't sell at a discount (short sale) if/when the market takes a dive again.

Quote:
I spoke with Wells Fargo, and he agreed with you guys above that moving the money to an IRA and then investing with that can cause huge issues with taxes if I dont do it PERFECTLY. He recommended just barrowing from my 401k and using the equity in my house. My only issue with barrowing is that I can only use half, which is not enough for a downpayment and closing costs on a 240k house unless I can get some lender to use my wife as a first time home buyer and let me use that status, since I bought my house before we were married and she has never been on a deed. Wells Fargo doesnt do this, but he said some other lenders do.
Don't quote me but I think the only way you can get the wife qualified as a first time buy is if you are able to do married filing separately for your tax returns. But again best to consult an expert. Don't want to be on the wrong side of the IRS. When I bought my 2nd house in '09 we didn't qualify for the tax break that was offered at the time despite it being the wife's first note (we weren't married when I bought the townhome).

Quote:
One thing I need to figure out that I thought of is, say I used 30k of IRA money to buy a 300k house, and financed the rest, so 10% is IRA money. If I turn around and sell the house for 400k, would all 100k profit have to go back into IRA in order to not pay taxes, or just the original 30 plus 10k for the 1/3 ROI? If thats the case, then Id be able to use the remaining 60k profit and move on to another house, without barrowing from IRA this time.
Again, you probably need to go over this plan probably with a tax lawyer of some sort. From what I bolded above, you can't obtain traditional financing if you're using a self-directed IRA. I also don't see how you can co-mingle tax-advantaged (IRA) funds and taxable funds for the purchase without really muddying the waters when claiming your capital gains. Again, you don't want to get in a fight with the IRS on that.
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