If you have a conventional IRA or a 401K plan with a mainstream custodian (bank, broker, employer etc.), your investments are typically limited to stocks, bonds, ETF’s, CD’s and mutual funds. These restrictions are often based on assets the custodians and/or IRA administrators recommend and sell. If you are heavily invested in the stock market, should you be diversifying in assets outside of stock market volatility? Have you ever considered investing your retirement funds in an alternative asset class beyond traditional options?
A self-directed retirement account is a tax-advantaged vehicle that gives investors the ability to invest in non-traditional options such as real estate, private equity, precious metals and cryptocurrencies. A Self-directed IRA or 401K plan can offer flexibility to invest in other assets and the opportunity to diversify outside of the stock market.
Individuals who self-direct their IRA and/or solo 401(k) enjoy the freedom and control these plans provide. Freedom lies within the massive number of alternative assets available to build wealth in these plans. And when you can invest in things you know and understand, you gain control over how your investment dollars are spent. Those who are savvy in business can invest in startups or distressed companies looking for a boost of capital to revamp. Venture capital and angel investing opportunities are permissible assets in self-directed plans.
Why Invest your retirement funds in Real Estate Syndications?
- Diversification: If you happen to own single family rental properties locally or if your retirement funds are primarily invested in the stock market, investing in multi-family real estate provides sector diversification. If you are invested in REIT, in comparison to Syndications they have higher fees, limited growth potential, they are volatile & inefficient. Syndication adds less volatility to your overall investment portfolio.
- Better returns: Average risk adjusted returns in a multi-family syndication is in the double digits and is higher than the average returns of the S&P 500 Index. Primarily this is due to the use of favorable leverage in comparison to buying stocks, mutual funds, or ETF at full face value.
- Passive Investment: The operations of real estate syndication is the responsibility of sponsors, general partners & property managers. As a limited partner, your investment is entirely passive.
- Professional Management: Multi-family properties are managed by a third-party management company and assets managed by general partners in syndication. Property management can be a full-time job in and of itself. Trying to manage your own property can be a recipe for disaster if you don’t know what you’re doing! There are many Federal, State, and Local laws to adhere to. It’s better to leave property management to the professionals.
- Investment Expertise: You can invest passively alongside sponsors who buy millions of dollars in investment property. The importance of a track record in real estate cannot be underestimated. As a passive investor, you can invest your capital alongside those with incredible track records. Try doing that with single family rentals – it is much more difficult! You’re all on your own in that case.
- No Personal Liability: There is no personal risk because investment as limited partners do not require a personal guarantee from the lender.
- Tax advantages: All income generated inside a self-directed retirement account grows tax free. If this is done inside a Roth account, all distributions at the time of retirement age can be tax free as well. If you can generate a higher rate of return, it can be a great tool to grow tax free wealth.
UDFI or UBIT Tax Implications for IRA Investors
Syndications use a combination of investor capital (equity) and bank debt for acquiring multi-family properties. This use of debt financing produces exposure to tax on Unrelated Debt-financed Income. In a property with a 75% Loan to Value, that would mean 75% of the net income produced by the property is subject to UDFI or UBIT Tax. Similarly, the gain on sale of a property that used debt financing could also be subject to UDFI or UBIT tax based on loan to value.
The Solo 401(k) Exemption
If a self-directed solo 401(k) plan acquire real estate through an investment in a LLC syndication, and a nonrecourse loan is part of the transaction, IRS would not subject the rental income or capital gain as acquisition indebtedness. As a qualified employer retirement plan, a Solo 401(k) is exempted from UDFI when the debt financing is used for the acquisition of real property. Rules for UDFI or UBIT can be complex, it is highly recommended to discuss your situation with a seasoned tax professional.
Multi-family syndication can be an attractive investment opportunity for savvy investors who want to diversify their retirement portfolio into real estate investments without having to deal with the headaches of being a landlord. These are passive investments that can offer great tax advantages, an opportunity to grow tax free wealth, diversification of alternative asset class and higher profits than you would get if invested in the S&P 500 Index or stock market.
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Happy Investing!