Setting up a SEPP 72T in a Self-directed IRA
L1: Setting up a SEPP 72T in a Self-directed IRA
I am born 08/30/1973. I have a pension with my former employer which I can take as a lump-sum of $243,000. I’d like to put this into a self-directed IRA. My question is whether I can then take SEPP 72T withdrawals from this self-directed IRA, or whether I can only do this from a traditional IRA.
2018-05-18 18:01, By: eriq, IP: [188.8.131.52]
L2: Setting up a SEPP 72T in a Self-directed IRA
You are allowed to do this, but usually self-directed IRAs are invested in ROBS (Retirement Owned Businesses). These are often real estate activities which may not generate the “free cash flow” needed to make the required annual distributions, in addition to federal and state income tax withholdings (which you can do by estimated payments outside of your SEPP).
I lecture to tax professionals against allowing clients to set up Self-Directed IRAs which invest in businesses and/or real estate. Many taxpayers think these are good ideas, but do not realize that they are not allowed to have any active part in these businesses or activities. The IRS has very strict regulations in this area, and a dedicated force of agents who audit these situations. So, be prepared to be audited.
2018-05-18 18:29, By: dlzallestaxes, IP: [184.108.40.206]
L3: Setting up a SEPP 72T in a Self-directed IRA
Thanks, good advice. As you guessed, I would be investing in a real-estate business, but I’m confident that a) the needed cash flow could be generated and b) I would not be taking an active part in the business. I’m interested to know other cautions you might have here.
2018-05-18 21:04, By: eriq, IP: [220.127.116.11]
L4: Setting up a SEPP 72T in a Self-directed IRA
1. All expenditures, including depreciation, are worthless because an IRA is not taxed.
2. You normally invest in real estate (or businesses) for an increase in value. You will be taxed at regular tax rates on the distributions, even if the rental operation loses money. If you made the same investment in a non-retirement account, the long-term capital gain would be taxed at 15%, instead of 22% or more.
3. If you have any period(s) of vacancy, or any major repair, it could cause you to have inadequate cash to make the required distribution for the calendar year. That would bust the SEPP retroactively from the start of the SEPP, subjecting you to a significant 10% penalty on all distributions from the beginning.
4. You cannot use a current property, and cannot rent the property to any related person. So, how else could you be sure that you won’t have any problems like those I mentioned in # 3 ?
5. It is difficult, if not impossible, to get a mortgage for a property in an IRA.
6. You will have to have a management company, and its related fees, which you would not have if it was an investment outside of the IRA.
2018-05-18 21:45, By: dlzallestaxes, IP: [18.104.22.168]
L5: Setting up a SEPP 72T in a Self-directed IRA
Thanks dlzallestaxes, you’re a huge beneficial resource for this site with your answers (I’ve read some of your exchanges with others). With regards to #3, perhaps I’m not understanding how distributions are made, but if I begin the account with $240,000, the calculation shows that my distributions are something in the neighborhood of $900/month. These distributions can be made from the investment earnings, or the principal of the original account, correct? I guess if I invest in an actual property, then the principal is not-liquid, so any distributions need to be made from the earnings. However, if the principal is still liquid, the distributions can be made from that principal, correct?
2018-05-19 06:07, By: eriq, IP: [22.214.171.124]
L6: Setting up a SEPP 72T in a Self-directed IRA
If you buy a property for $ 240,000, you may not have $ 10,800 per year in cash flow profits to distribute EVERY YEAR. There could be periods of vacancies, or expensive repairs (like a new roof or HVAC). You would not be allowed to contribute more cash to pay for them, or to pay real estate taxes or insurance. In those situations, where would the required $ 10,800 come from to distribute to yourself ? If your balance in your IRA is that amount, you might want to buy a property for only $ 200K-$ 225K, including settlement costs, and keeping the rest for contingencies.
Before proceeding, you should do a projection of Net Cash Flow of Rents Received vs. Cash Expenditures, including Mortgage payments if applicable. You should probably provide for maintaining a Cash Balance of at least $ 11,000 at all times to cover the required annual SEPP distributions in case of any of the contingencies I mentioned. In addition, I would recommend monthly distributions, rather than annual ones, in order to minimize the chance of busting the plan by having a cash shortfall.
2018-05-19 18:29, By: dlzallestaxes, IP: [126.96.36.199]
L7: Setting up a SEPP 72T in a Self-directed IRA
Thanks, very good advice and forewarning . . . . .
2018-05-19 23:07, By: eriq, IP: [188.8.131.52]
L8: Setting up a SEPP 72T in a Self-directed IRA
Another important piece of information — We usually warn people about the tremendous penalty of 10% of all distributions from the beginning, which means in your case that you must make the total annual distributions for the next 15 YEARS, until you are 59 1/2. If you bust the plan in the last year, after 14 successful years in which you withdrew about $ 150,000, the penalty will be $ 15,000 in addition to the taxes you paid every year.
There aren’t many people who can do that when they have normal investments that are liquid. It is almost impossible to do it with an illiquid investment in rental real estate.
2018-05-20 05:23, By: dlzallestaxes, IP: [184.108.40.206]