Jeff Dixon, MBA, CISP, SDIP
Does your Self-Directed IRA or Solo 401(k) have assets in it? If so, those assets may have expenses. 100% of expenses related to IRA assets must be paid for by the IRA. As a result, you are required to leave a “pad” of extra cash to cover IRA expenses because you cannot pay those expenses personally. That’s why your self-directed account needs cash reserves.
Cash Reserve Requirements:
When a Self-Directed IRA buys physical real estate, we require the IRA to have a 10% cushion of the purchase price. For example, if the sales price was $200,000, the IRA would need $20,000 left after closing in the IRA.
Again, all expenses of the IRA must be paid for by the IRA. Because paying real estate related expenses personally can lead to a Prohibited Transaction the ten-percent hold-back is essential. It does not stop distributions and paying vendor bills. What it stops is new investments when you have real estate in the account with the 10% hold-back. It is a red flag for us to look and ask the question as to how the account holder plans on keeping the property functional. The reserve funds are a way for us to make sure that you (account holder) are able to keep the property in good working order, pay taxes, repairs, etc. This does not apply to investing in a business that buys real estate or making a loan secured by real estate.
Question from a Syndication Attorney:
“Because of the interest rate cap issue, my clients are anticipating having capital calls. Here is the issue that came up: An investor invests $100,000 through their self-directed IRA. The capital call is for $10,000. IRA has no money, and they can’t make an additional contribution. If the owner of the IRA sends the $10,000 out of their personal acct, will that be a prohibited transaction? Penalty?”
The answer is yes, using personal funds for the capital call would be a prohibited transaction. The IRA could be distributed and the client would then have to pay taxes. If under the age of 59 ½, there will also be a 10% penalty.
If you are doing an investment where additional capital could be required, it is important that you take steps to insure your account can face situations like this. This is why your self-directed account needs cash reserves.
Final Thoughts:
In general, we always require the IRA to always have $325 in cash in the IRA. You can never invest 100% of the funds into assets.
Consulting a tax professional when deciding between retirement plans (or any decision regarding a retirement account) is a very good idea. Feel free to contact us if you have questions about this or any IRA-related topic. uDirect IRA can send information on how the retirement plan makes these investments. Reach out to us at (866) 706-2798 or info@uDirectIRA.com.
