Back a few years ago, when the real estate market was booming, self-directed retirement accounts were making loans on investment properties; duplexes, triplexes, and fourplexes. The going rate was 8 to 10%. The loans were secured with a 2nd on the investment property and usually with interest at note maturity in three years.
This is typically a good investment for a self-directed IRA or 401(k) — but read on.
Fast forward to today. The 1st mortgage on the investment property was a negative amortized loan that has now reset. Instead of paying interest only (or less), the investor is faced with a mortgage payment that clearly takes them out of a positive cash flow position. Positive cash flow and a tax loss (nirvana) for an investor has now turned into a disaster.
The investor calls and says they can no longer make the payments and are going to let the bank take the property. Yikes! The self-directed retirement fund is in 2nd position, right behind the bank’s interest in the property.
What could have been done better in this situation?
- Earlier payments would have helped; perhaps taking monthly, quarterly, or even annual principal and interest payments.
- Interest-only payments would have helped.
- Taking a 2nd on the investor’s home might have helped. An investor may be more likely to keep their primary home payments up-to-date.
What could be done in the future to recover?
- Because the owner of the self-directed retirement cannot sign for a new loan, the self-directed fund needs a partner.
- The partner would, of course, be a qualified person. In other words, able to do business with the self-retired fund without triggering a prohibited transaction.
- Perhaps a short sale could be negotiated, allowing the property to be rented with positive cash flow. This would give time for the investment to mature and gain capital appreciation over the coming several years.
- The property would be sold in the future with the self-directed account capturing at least the beginning investment at that time. Now that would be Nirvana!