What to Expect When Investing in Syndications with Alternative Retirement Plans
Disclaimer, we are not Certified Public Accountants or legal retirement fund advisors. Any and all content herein is based on personal experience, knowledge and opinions. If you seek legal advice, please speak with your CPA or retirement fund professional.
By now, you’ve already discovered that the lazy cash in your retirement funds can do so much more for you when invested into alternative vehicles such as real estate. Reading over some of the initial strategies and knowledge in regards to alternative investments is a great place to start. Part I and Part II of this 3-part series are linked below for easy reference.
In this article, we are going to cover what to expect when investing in multifamily syndications with alternative retirement plans such as Self Directed IRA or Solo 401K plans.
Funding The Syndication
Did you know that it is possible to fund an apartment syndication with your retirement plan? Once you get comfortable with the idea of using these funds in this way, the procedure is likely very similar to other types of investments. However, funding procedures are slightly different between Self Directed IRA accounts and Solo 401K primarily because of the way they are managed. A Self Directed IRA typically has a custodian that acts on your behalf in terms of reviewing, signing documents and funding investments. A Solo 401K is usually managed by the owner and contributor of the account.
One important thing to note is that you should have your alternative retirement funds set up before you even think about investing. The process of establishing these accounts may take up to eight weeks. Standard multifamily syndications usually close funds 60 days or earlier. For popular syndicators, their project might be fully funded in a couple of hours. We had one project that was fully committed within four hours! So you do not want to miss the opportunity because you didn’t have all your items lined up.
So how do you start? You will need to first open an account, then fund the account by transferring your past 401K plans into the alternative retirement plans. If you have Solo 401K, you should also open a bank account that accepts ACH transfers. Most apartment syndicators no longer issue checks for distributions.
Self Directed IRA
If you have a Self Directed IRA account being managed by a custodian, you will need to make sure everything is done through your custodian. Remember the “arms length” stipulation for transactions and using funds from the account? If you need a refresher, read over Part II of this series to find out more.
After indicating that you are interested in an investment, fill out the commitment form from the syndicator and indicate you intend to invest with a Self Directed IRA. This helps the syndicator identify the extra steps they need to take for you. At this point, reach out to your IRA custodian to indicate your interest. He/she will then request project information from the syndication team.
I often find that including syndicators and custodians in one single communication chain helps us move forward faster.
As you go through the investor questionnaire for the project, indicate you are investing with a Self Directed IRA or retirement fund. Self Directed IRA is typically NOT an ERISA (Employee Retirement Income Security Act) protected vehicle. From there, fill the form with your IRA account information.
When it comes to signing of the documents, you will need to indicate that your custodian needs to be the signer. In some cases, you might have to print out that signing form to send to your custodian for signature. You will authorize your custodian to sign. Then they will sign it on your behalf. Either they or you will make sure this signed form gets back to your syndicator to complete the process. Ask for an all signed copy and make sure your custodian has it on his/her file. Sometimes the copy will not be fully executed until the project closes.
You will also need bank information for the firm that holds your Self Directed IRA in order to fill out ACH forms from your syndicator. The ACH form is used for the syndicator to send distributions once the project gets up and going. Typically, each Self Directed IRA company has one bank for all accounts. When creating the ACH instructions, provide your IRA account number so your syndicator can include it in their notes when they send distribution payments to you. You can easily find this bank information from your custodian.
Once all forms are signed, contact your custodian to give them instructions to send the fund to the investment.
Solo 401K
When using a Solo 401K for a syndication project, fill all the documents out as if the Solo 401K account is your double. A Solo 401K is a retirement account and usually a trust. You will indicate it as such. It is also NOT typically ERISA (Employee Retirement Income Security Act) protected unless it is an employer-sponsored 401K plan.
Unlike Self Directed IRAs, you are the trustee and account owner. There is no custodian. You will sign as the trustee of the Solo 401K.
It is super important that the funds from your Solo 401K are never mixed with personal spending money. This is due to the nature of using the Solo 401K account for investing purposes. When you keep these transactions separate, you are setting yourself up to avoid penalty taxes. (Again, we always encourage you to speak with your CPA and retirement account managers before taking any definitive actions with these accounts.) This is where the bank account you opened for your Solo 401K Plan comes in handy. You MUST fill out the ACH form from your syndicator with the bank account for your Solo 401K Plan NOT your individual account. DO NOT transfer money between your Solo 401K Plan account to any individual accounts unless you want to pay the penalty for early withdrawal from your retirement account.
With Solo 401K accounts, the process of signing and funding the syndication project is much simpler. You can sign the documents and fund the investment yourself as the trustee of the Solo 401K Plan. This saves time and helps you get into popular syndications.
Deciding on an Asset Class
Fixed Rate Returns
Some syndicators now offer two different classes of investment options for real estate. “Preferred Equity Class” is a type of investment that is similar to debt investment. It provides a fixed rate return and usually is the first priority in terms of payout order. In other words, this asset class usually gets paid before others else gets paid. This class usually does not participate in the upside of equity. It is fantastic for Self Directed IRA accounts to invest in this class. Since the return is not benefitting from the debt leverage, it is likely not subjected to UDFI/UBIT tax mentioned in our previous article.
Equity Returns
The big benefit of investing in real estate is equity gain. However, if you invest in this class with your Self Directed IRA, you may be subject to UDFI/UBIT tax, which eats into your profit. However, your losses in your Self Directed IRA account can be used to offset future gains to reduce the tax. If you are investing with a Solo 401K account, you are not subject to UDFI/UBIT tax typically. All is not lost. You can always invest with a Self Directed IRA account first and then later change your investment into a Solo 401K account since usually it will be a couple years of holding for multifamily syndication.
Switching Investments From Self Directed IRA to Solo 401K
It may be that you are not qualified to have a Solo 401K when you first start investing. During the holding period of a multifamily project, you may find yourself starting a side business and are now qualified for a Solo 401K account. You can then transfer your Self Directed IRA funds to your new Solo 401K account. You will need to reach out to your custodian about this transfer, however. They will ask your syndicator to sign a membership transfer form. Once signed, you want to make sure you update ACH information used for distribution to make sure new distributions go into your Solo 401K account. You will likely expect two tax returns that year from the same investment - one for your old account and one for your new account.
Tax Returns
Make sure to complete and submit a W9 form for your syndicator using Self Directed IRA or Solo 401K information. Request this information from your custodian if you have a Self Directed IRA account. This way, you will get a tax return for that account. Since the retirement plan is tax deferred, there is not much tax benefit for this type of account.
Fair Market Value Report
You will need to make sure to stay in touch with your syndication team to provide a copy of the Fair Market Value Report each year, at the beginning of the year. This is a report indicating your investments’ fair market value. Expect the value to be relatively low and conservative. It is used to calculate your UBIT/UDFI tax for Self Directed IRA accounts that year. For real estate holdings due to all deductibles, you likely won’t be paying any UDFI/UBIT tax until the property is sold. Some major Self Directed IRA companies require this form at the beginning of the year. They may impose a penalty fee if this report is received late.
The Fair Market Value Report is also used to calculate the total value of your retirement account. If you have a Solo 401K, be sure to request this report as well. If your total account value exceeds $250K, you will need to file a Form 5500-EZ. It is due on July 31st of the next year from the current tax year.
Selling the Syndication Asset
Every project comes to an end. It is best practice to consult your accountant and custodian when you know a project is likely about to be sold. This way, your accountant can plan appropriately for UDFI/UBIT tax if you invested with a Self Directed IRA. You want to make sure money is wired to your retirement account instead of your individual account to avoid early retirement withdrawal penalties.
We hope this series of articles helps you navigate investing in real estate and multifamily syndications with alternative retirement accounts. Leave us a comment and any questions you have around this topic. We look forward to hearing from you.