I Bought a Rental…
This post will answer some of the common questions we get about how a piece of rental real estate would be handled in an IRA LLC.
A lot of people get that an IRA LLC can buy property, but they sometimes have questions about how the nuts and bolts of keeping the property in the LLC. For example, where do the rents go? Who pays the taxes? What happens if I have to move out a renter? What if the property needs some repairs?
Before we get into the details, let’s remember one thing: Buying and renting a house using an IRA LLC, and buying and renting a house with personal funds, is more or less exactly the same. There’s nothing special you have to do; just keep a few rules in mind, and wrap your head around a couple concepts.
Once you’ve closed on a property, the LLC is the owner of the house. The deed is recorded in the LLC’s name, and the house is owned by the company. So, let’s follow that up with the question “What happens to the rents?” It should be obvious that the renters would write their rent check to the owner of the property each month, right? So, the rent checks would be made payable to the LLC. Where do the checks go? Well, since you’re the Manager of the company, you can have the renters mail the checks to you, or to a PO Box you set up in the LLC’s name. When the check(s) comes in, you would run down to the bank, and deposit the funds into the LLC’s checking account. Easy peasy.
TAXES & UTILITIES
Alright, so who pays the taxes and utilities? Once again, the LLC owns the property, so it is ultimately the company’s responsibility to pay those bills. However, what if you want the renters to pay the utilities, or some of the utilities? As the Manager of the LLC, you get to decide under what circumstances the LLC will be renting the property. So, whatever it is you decide on – the renter will pay no utilities, or all utilities, or just water and sewer, or just power, etc – you would just make sure that the rental agreement spells out those particulars. Renters hardly ever pay any property taxes, so it would be the LLC’s responsibility to pay those taxes. How do you do that? Write a check to the county. See? I told you it was easy.
It’s 3am, and your phone starts buzzing, causing you to dream a giant egg beater is chasing you down the street. You wake up in a sweat to find that its just the renter calling to let you know a giant pool of water has formed on the upstairs bathroom floor, and is beginning to cascade down the stairs. What now? Well, the first thing is to get the water shut off, but after that’s handled, how do you go about getting the pipes repaired since we’re dealing with an IRA LLC? The answer is one you might expect. You’d do the same thing you’d do if you owned the property personally – you’d call a plumber and tell him to get the thing fixed. The only difference is that in this case, the LLC owns the property, so the plumber would be doing the job for the LLC. He’d invoice the LLC, and you would cut a check from the LLC to pay for the parts and labor. What about a new roof, electrical issues, or new carpeting? Apply what we just went through, and you’re there.
Here are the concepts you should focus on. The LLC is an LLC like any other LLC, in the sense that it can own property, have bank accounts, loan money to people and enter into agreements or contracts. Whatever it is you decide to invest in, that investment is an asset of the company. Any expenses that are related to that investment or asset need to be paid by the LLC. In this case, whatever repairs, taxes, etc… come up on the property, it is the LLC that must pay these expenses, because the LLC owns the property.
Then this – since you are the Manager of the LLC, it is you that gets to decide what is invested where and when. You get to decide if the roof looks good, or if you need to get on the phone to Fred to schedule to come do a layover, or a complete tear-off and re-roofing. You get to haggle with Fred on what the cost will be, and when it comes time, you cut a check from the LLC’s account to Fred, to pay for the work done.
You can see that the process of investing, the process of collecting rents, of ordering repairs, of paying taxes, etc… is no different than if you were the owner of the property. The only difference is that the property is owned by an LLC, and you’re the Manager of that LLC. So everything you do is always in the name of the company, and you’re always doing it in the capacity of Manager.
Hopefully this post is helpful, but you might also read another post entitled “Can I Manage an IRA LLC Owned Property” where I deal with the question of how much you can involve yourself in the actual management of the IRA LLC owned property.
Can an IRA take out a mortgage for an investment property or does it have to be paid in full?
IRAs can certainly take a loan from a bank or private party. The loan has to be non-recourse, which is to say that you can’t personally guarantee the loan, and the bank’s only recourse will be to take back the property. Because of that, lenders generally will not loan as much. From what I’ve seen, you can expect anywhere from 40%-60% LTV for a non-recourse loan.
Make sure though that is a non-recourse loan. There was a case (Peek v. Commissioner) that shows what happens when an IRA owner personally guarantees a loan made to their IRA. In Peek’s case, it was a Corp that was owned by several IRAs. The loan was made to the Corp, but guaranteed by the IRA owners. The tax court disqualified their accounts. Ouch.
There are a couple places you can go to get rates for non-recourse loans, although these aren’t by any means the only places that do non-recourse loans. http://www.iralending.com and http://www.myiralender.com
Be aware that financing property in an IRA will trigger the Unrelated Debt-Finance tax; this is commonly referred to as UDFI. The IRA will have to pay taxes on the portion of the net profits that were made with the bank’s money. Make sure you deal with a knowledgable CPA who can handle the 990-T filing for the IRA and correctly calculate the deductions, depreciation, and tax liability.
Finally, make sure there are no carve-outs in the loan documents. Carve-outs are kind of like exceptions to the non-recourse status of the loan. Put another way, they are clauses in the note that establish circumstances under which the IRA owner is personally liable. Many times they are called “bad-boy” clauses. Here’s a pretty good article on the subject.