I apologize if this post is duplicative of prior posts, but I couldn't find anything directly on point when doing a search. Feel free to provide links to relevant info.

I currently have a traditional IRA, which is invested in equity mutual funds with one of the big mutual fund companies. A friend of mine is a real estate investor; his company creates separate LLCs for each new real estate investment.

I'm looking for guidance on the steps to get to making this investment. My guess is that I need to do the following and questions on these steps:

1. Have the mutual funds sold (still within the IRA).
2. Convert to a self-directed IRA.
Question: How do I do this? Can I just tell the mutual fund to send me a checkbook and I write a check off the IRA?
3. Have the IRA now purchase interests in the LLC
Question: Any tax issues I need to be concerned about?

If there's anything else I need to know, please feel free to mention it! For purposes of this post, assume that the investment is legitimate (so you don't need to warn me about investing in real estate partnerships).

Thanks!

There are lots of things you need to be concerned about. First you'll need to find a Trustee/Custodian that will hold the ownership interest in the LLC. Not sure that will be very easy. Then you need to remember that any earnings/profit from the LLC is owned by the IRA. Also, if there are any additional amounts that you have to contribute (split expenses, etc.) that will need to come from the IRA.

This is probably cleaner than owning the real estate directly, but you still need to get some help from someone that has done this before.

You need to have a purchase agreement which instructs the IRA custodian to subscribe to a purchase of shares/units in the LLC in return by making a contribution of X dollars. You need to hire a tax advisor and specialist in creating LLCs under state law to avoid creating a PT. There are IRA custodians who will hold RE but they charge high fees e.g., $1000 per yr to act as as IRA custodian. Remember all expenses for the RE (eg. taxes, ins., utilities,etc) should be paid LLC so the LLC will need sufficient liquid assets. If you do not follow complex rules (see the Swanson case) you risk disqualfiying the entire IRA.

And.... the UBTI problem can still lurk.

As noted by folks above, while it is not impossible, it is darn difficult. Remember that your IRA/Roth may also not be pledged as collateral.

You also lose some of the tax benefits associated with real estate ownership. For example, you lose the long term capital gains treatment, and also can not write off real estate losses. I am currently in ten LLPs involving real estate. These range from office bldgs (John Hancock tower in Boston), to apartment complexes and Euro shopping centers. I don't have any IRA/Roth or retirement funds in any of these.

See this link for some of the issues:

http://benefitslink.com/boards/index.php?s...987&hl=UBIT

Do not make assumptions about what might be OK. Too much is at risk. Hire at least one tax professional familiar with real estate dealings and tax shelter retirement accounts. Do not rely upon "my friend, the real estate investor" for tax advice.

Also, there is nothing magical about separate LLCs for each investment, that you mention this makes me wonder how much you know about how real estate deals generally get done. Do you know about cap rates, promotes, claw backs, and oversight functions given to investors in these deals?

You also give no indication about your age, professional training, experience or the size of the assets you are talking about. The only hint you provide is that you currently have mutual funds. Real estate deals require more sophistication than company evaluations in my opinion. For example, I would respond differently if you have seven figures in assets and more than a 20 year base of business experience compared to someone ten years out of college and say 100K in assets.

You have a much higher risk of getting hurt in single LLC investments then in mutual funds.

I hope you will accept these words of caution.

Thanks everyone.

John G, to your post, I mentioned that the RE investment was through an LLC to distinguish it from direct ownership of real estate (otherwise, would get comments regarding expenses to upkeep the property, property taxes, etc.). I wasn't trying to say there was anything "magical" about an LLC.

I wasn't sure how to assess you comment about loss of LTCG rates and inability to take losses. Currently, I'm invested in mutual funds in the IRA. Since it's an IRA, I also don't get LTCG rates and can't deduct losses...is this any different from owning a real estate LLC? Since it's in an LLC, I don't have the ability to 1031 exchange either. I think I'm net indifferent regarding passive income as I've got plenty of passive loss carryforwards from other investments, but I suspect they aren't taxable in an IRA.

Fortunately (or unfortunately), the IRA isn't that big. While I'm not a real estate expert, I do have to be an "accredited investor" to invest in these LLCs.

The UBIT info was useful. I'll have to find out from my friend if they anticipate any.

If the IRA account is small, it probably is not worth the hassle (search for a custodian, extra annual fees, appraisal issue, etc.) of doing real estate, LLC or not. The more "local" the deal, the more difficult to get a custodian to allow the transaction - bear in mind, they don't want to be on the hook for anything that could be consider unsuitable. Its also harder to approve a transaction when there is minimal track record of the general partner.

You are correct about LTCG treatment is the same, regardless of the investment. Some real estate deals make more sense when you can utilize the tax losses/write-offs.

The issues I raised (lack of diversification, deal evaluation, liquidity, etc.) are significant hurtles for investing in real estate. When you opt for the LLC route, you have minimal input into the decisions, timing and risks undertaken. I did not think you made a very compelling case for sending money to your real estate friend.

The "sophisticated investor" threshold is defined by assets/income, not actual investment knowledge. The SEC is worries more about the retail investor. When you are classified as "SI" or "QI" (QI is a higher level, both are self declared) they expect you will hire your own financial advisors, lawyers and accountants. The process is designed to keep small players out of complicated investment vehicles which are not heavily scrutinized by regulators.

You indicated that you were not a real estate expert. That suggests to me that you should not participate in these deals.