Did you know you can invest in syndications through your retirement account?

It’s true! And there is a big advantage to leveraging this money — that is otherwise just sitting there — to get the fantastic returns that come from commercial real estate.

Bottom line: you’ll get better returns from a real estate syndication than you will earn in an average IRA.

But you need to have the right kind of retirement account, to be prepared ahead of time, and to be aware of the potential taxes you may incur on the profits.

So let’s cover each of those topics, one at a time.

What Type Of Retirement Account Do I Need To Be Able To Invest In Real Estate?

First we need to distinguish between a self-directed IRA and a 401k that is established by an employer.

The employer plans are not eligible for investment in real estate.

So we are going to focus on self-directed IRAs.

And often the next question is “what is the difference between a self-directed and a traditional IRA?” Well, basically it just comes down to marketing terms. At their base definition, all IRAs are the same. However many traditional IRA providers only allow for investments in stocks and bonds. So that is not what we want.

Next we need to choose a custodian that will allow for investments in real estate. And we want to double check that they include the option for multifamily syndications — because some allow for residential real estate but not commercial syndications, etc. You’ll need to speak to the firm that manages your retirement account to check what options they have available.

If your current IRA custodian can’t accommodate you, then you can move your IRA to a custodian who can.

How Can I Prepare My Retirement Account To Invest In A Commercial Real Estate Deal?

Let’s say you have checked on all of the above, and that the custodian of your self-directed IRA will allow you to invest in multifamily syndications.

There are some steps that take place during the funding period, so you will want to be prepared ahead of time.

There are two factors to focus on here:

  1. Document execution process
  2. Ability to receive electronic deposits

Your custodian will have to sign for every transaction on the IRA. So each time there is a document that needs to be signed, you should know what type of process to expect, and how that will affect the timing. For example, does your custodian refuse to accept DocuSign and instead require an actual paper document with a wet signature? That will delay the deal (and possibly cause you to miss out if the sponsor is over-subscribed and can just move down the line to the next investor).

And about deposits, some custodians insist on paper checks, whereas most syndicators require electronic deposits (ACH/wire) to pay out distributions.

Each of these factors should be checked with your IRA custodian long before you find an actual deal that you are interested in.

How Will I Be Taxed On Investments Made From My Retirement Account?

There are some tax implications for using a retirement account to invest in real estate.

If you get income from an investment that has debt associated with it — as real estate syndications do — then that is considered Unrelated Business Taxable Income (UBTI). UBTI is subject to the Unrelated Business Income Tax (UBIT).

Lots of acronyms to remember: REI from an IRA generates UBTI that is subject to UBIT!

There is a way you may be able to avoid paying UBIT, but we’ll get into that below. First, it’s a good idea to understand a bit more about the taxes you may owe when using retirement accounts to fund real estate deals.

UBIT applies to the portion of your profit that is leveraged. Capital gains in an IRA are only paid based on the debt-leveraged percentage of the property at the time of sale and 12 months prior.

On a typical $50K real estate investment and a 5-7 hold period, you could end up paying low five figures in taxes.

That’s not the end of the world, but it’s better to be aware of it ahead of time.

And now, we get to a strategy where you can eliminate this UBIT burden.

Is There A Way To Avoid Taxes When Investing With A Retirement Account?

Yes!

You’ll need a special type of Qualified Retirement Plan (QRP) called a Solo 401k.

Now don’t confuse this with the employer 401k plans we mentioned above. This QRP is a self-directed retirement account where you act as your own custodian/trustee.

In the Solo 401k, you control the account and you sign your own paperwork.

There is one downside of setting up this special QRP: as of this writing it may cost around $3K to start.

However, if you compare that to the tax burden we detailed above, you will still come out ahead. And if you plan on investing in more than one real estate syndication via your retirement account, then the tax savings will be huge.

Most of the major investment firms and brokerages offer Solo 401k services.

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So, in summary:

  • you can use retirement accounts to invest in commercial real estate syndications
  • but only certain providers can accommodate that
  • and you must be aware of the tax implications of doing so, or use a vehicle that avoids the taxes altogether