BUYING REAL ESTATE WITH AN IRA AND A NON-RECOURSE LOAN · 1. How a SDIRA invests into real estate 2. Why you must use a “non-recourse loan” 3. Non-Recourse loan terms, options,

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

[email protected]

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

[email protected]

Phone 800-908-8845

http://www.sdirahandbook.com/

http://www.kkolawyers.com/

http://www.myiralender.com/

mailto:[email protected]

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


http://www.ici.org/info/ret_13_q4_data.xls

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


Purchase Price $184,000 Residential Home with HOA

Loan Amount $92,000

Gross Rental Income $15,600 ($1300/month)


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


Purchase Price $600,000 Commercial Building

Loan Amount $300,000

Gross Rental Income $60,000 ($5000/month NNN)


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%


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


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


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

[email protected]

Serving Clients Nationwide From Our Offices in Arizona, Utah, and California

THANKS


http://www.matnsorensen.com/

http://www.kkolawyers.com/

Documents

BUYING REAL ESTATE WITH AN IRA AND A NON-RECOURSE LOAN · 1. How a SDIRA invests into real estate 2. Why you must use a “non-recourse loan” 3. Non-Recourse loan terms, options,