Each day we speak with dozens of investors looking to put their retirement plan to work in real estate with the aim of producing better results for their financial future. With a self-directed IRA LLC or Solo 401(k) plan, diversifying into real estate can be a great way to create future wealth for your golden years… but what if you want to produce results for yourself today?
It is possible to use existing retirement funds to capitalize an active real estate development company. You can run the company and draw a salary, all without taxes or penalties. The Safeguard Business Funding IRA makes this possible.
Unlike a self-directed IRA or Solo 401(k) plan, which must be deployed entirely at arm’s length and exclusively for the benefit of the retirement plan, the Business Funding IRA – sometimes referred to as a Rollover as Business Startup or ROBS plan – allows you to be directly engaged in the business activities.
For many investors desiring to create their own real estate focused business, this can be an incredible opportunity.
What is a Business Funding IRA?
The Business Funding plan is a combination of several components that allows you to capitalize your own business using retirement funds. The concept is as follows:
- A subchapter C Corporation is formed to be the operating business
- You act as an owner/employee of the corporation
- The corporation sponsors a 401(k) or Profit Sharing retirement plan
- As an employee, you can rollover existing tax-deferred IRA or 401(k) savings into this new company retirement plan
- The retirement plan then purchases shares of the parent corporation using an Employee Stock Option Purchase (ESOP).
- The business then operates as any normal corporation would, with the capital used to acquire assets, pay for operating expenses including salaries for you and any other employees, and receive the income produced by the business activity.
There are no taxes or penalties for using retirement funds to become a shareholder of the corporation. Of course, the corporation itself will operate as any other taxable corporation would, and profits to the company or salary you take will be taxable.
This Rollover as Business Startup has been in use since the 1980’s and is fully IRS compliant when implemented and managed correctly.
In 2016, this ROBS plan format was used for approximately 20% of all franchise business startups or secondary acquisitions.
Our team at Safeguard Advisors has been helping clients implement such plans since 2005, with client using the structure to establish restaurant franchises, insurance agencies, retail businesses and, yes, real estate development companies.
The Real Estate Development Model
If your goal is to actively flip properties or engage in new property development, the Business Funding IRA can be a great tool for the job.
Flipping and new development are actually models of real estate investing that do not fit well in a classic self-directed IRA. Since these activities are considered to be a trade or business, an IRA that engages in such transactions on a regular basis is subject to Unrelated Business Income Tax (UBIT), which can be as high as a 39.6% federal tax. The idea of UBIT is to protect tax-paying businesses from unfair competition by tax-exempt entities like a IRA or 401(k) plans.
These more active types of transactions are also difficult to execute in a truly arm’s length fashion, which is required for a self-directed IRA LLC or Solo 401(k) plan.
With the retirement-funded C Corporation, neither of the above is a factor. Your corporation can buy/fix/sell homes or build new spec homes without the extreme tax consequences an IRA would encounter. The corporation will pay normal rates, which currently max out at 35% and may go lower depending on planned congressional actions. As an owner/employee of your corporation, you can be actively engaged in the business, and act as a project manager or even hang drywall and paint if you like.
Retirement Funds are Just One Piece of the Pie
While the primary purpose of implementing the Business Funding IRA is to allow for access to existing retirement funds, your business is not limited to this one source of capital.
You can also be a shareholder of the company personally, so if you have after-tax savings you would like to add to the mix, you can do so.
Your corporation may also have other investors such as friends & family.
The corporation can also use debt-financing such as SBA loans or conventional real estate instruments like lines of credit or new construction loans, as well as loans from private parties.
The Wealth Building Angle
Being able to operate your own real estate development company and make a living is great, but what about building real wealth for your future? If you can grow your business to a successful level, the Business Funding IRA offers two means by which you can create tax-sheltered savings.
In addition to drawing a salary, you can make new contributions to the company retirement plan a part of your compensation. Any contributions will be tax-deferred and reduce your overall tax burden, just like any normal 401(k) or Profit Sharing plan. Plan limits can be as high as $60K per individual or $120K for a married couple.
Your company can also issue shareholder distributions as profitability allows. Any dividends issues to the plan-held shares will be placed tax-deferred into the plan, just like dividends of Apple or Amazon would.
If you are interested in learning more about this unique approach to wealth building, or want to compare the Business Funding IRA strategy to a passive self-directed IRA, please feel free to contact your Safeguard Advisor today.