Using Self Directed Roth To Purchase Option?

I've just opened my Roth and have only $5,000 in it, but I understand that I can use any portion of those funds to purchase an option on property and if successful, any profits are returned to the Roth tax-free. So, here's what I'm thinking, please let me know if you see any 'holes' in my theory:

I'm submitting a short sale for $110k on a property worth $200K. I'd like the 'buyer' of the property be a land trust, rather than me personally, so I can make my brother-in-law the trustee. My Roth would then pay him an option fee of $10 to purchase the property at $120K, then sell the property wholesale to another investor for, let's say $140K and pocket the difference tax-free.

Would something like this work? Any thoughts or advice are appreciated in advance!

Bob

How have you established that $10 is the market rate for an option? Plus it sounds like you're doing all this with related parties, which would run afoul of the IRS self dealing rules.

I think you should seek legal advice on this strategy. Go to the attorney who is helping you with the land trust (I assume you have an attorney assiting with that).

well a brother in law is not a disqualified person since he is not of lineal descent. Perhaps you should do some reading before making assumptions!

http://www.trustetc.com/investment/prohibited-ira-transactions.html

Who cares how much the option fee is since it's irrelevant to the transaction

I misread your post. Sounds like you're taking title to the property in a land trust, then using your Roth to purchase it (essentially from yourself). Still appears to run afoul of self-dealing rules, but I'd guess someone else will weigh in here. Specifically the IRS website (from your URL) says: Examples of Prohibited Transaction/Self Dealing:
With yourself - Having your IRA purchase real estate that you own presently." Since you own the trust and the Roth, how do you avoid that?


[ Edited by finniganps on Date 03/20/2008 ]

Thanks, I've gotten the full scoop from my custodian, Equity Trust. They don't advise on process, only on the IRS regs, so this is why I'm looking for advice on this forum for procedures and implementation advice. I'm hoping that having a non-lineal descented act as the intermediary for the transaction will meet the regs

How do you avoid the self dealing though since you own the trust and the Roth (see my previous post since being edited)?

Why do you say that I own the trust?

A land trust can be set up with any party as the trustee and any parties as the beneficiary, right?

You purchase for $110K and option to your IRA for $120K. Your IRA sells the option to another investor for $140K. At the settlement table, your IRA gets $140K, than pays you $120K and keeps the difference in the IRA. You take your $120K and pay the bank $110K, keeping $10K for yourself.

In the end, the investor bought the property from your IRA which in turn bought the property from your trust. You get $10K and your IRA gets $20K.

I agree with finniganps. You appear to be selling the property from your trust (you are the beneficiary, so your trust) to your IRA (which you own, right), so I also would be concerned with the related party and self-dealing issues.

Why not simplify the whole thing. Get the short sale approved, then assign your purchase contract to your IRA. Now, your IRA can assign the contract to a third party and collect whatever assignment fee the market will bear.

finniganps, will this pass muster?

Well, two things:

1. Usually the bank will not allow assignment on a short sale

2. Why do I have to be the beneficiary on the trust? I was thinking that my brother in law would be the beneficiary.

An independent 3rd party would not agree to what you are suggesting. IMO - the IRS won't agree either. IMO - this would not qualify as a bonfide transaction between two unrelated 3rd parties. I think Newkids suggestion is the closest thing to what you are looking for, but it wouldn't likely generate the profit you are thinking because the market wouldn't likely pay that much for the fee. I think you should seek professional assistance at this point - you're tax planning is very aggressive IMO.

Globalvillage:

Certainly profiting from an option transaction within your Roth is one of the fastest ways to enhance the tax free value of your Roth.

Your goal is to stay clear of self-dealing- directly or indirectly.

There are aspects of this transaction which you should clarify. I just don't understand.
1.You say that you(??) are submitting an offer on a short sale. Then, you say that the "buyer" will be a land trust(LT).
Who specifically is making the offer to the lender? Who will be able to demonstrate to the short sale lender their financial capability? How will this property be acquired?-all cash or with financing?

2. Your brother-in-law (BIN)is the Trustee of the LT. You say that your (BIN) will also be the beneficiary.Hold this discussion for later because it will only muddy the waters. Who will the trustor be? Is the LT intended to survive the resale of the property for $140k or will that event terminate the LT.

There are a number of other questions regarding the process but I wait until you respond to question #1 and secondarily to #2.

Well, I was planning to submit the short sale purchase agreement signed by me, Trustee, then have my BIN be the Beneficiary, then perhaps have him assign Beneficial Interest to my Roth, but the attorney who I spoke with this morning said that since I'm the one making the purchase offer, it would be considered self-dealing.

If you have any thoughts on alternative strategies to do this without violating any self dealing regs, please let me know.

Thanks.

I thought when you said that "you" were making the offer that this was a prohibited transaction. I just needed clarification.

Had the transaction gone forward the assignment of the beneficial interest to your Roth would also be a prohibited transaction and an excess contribution to your Roth.

Is there anyone brother,sister,BIN,or friend who has the financial capability to buy this short sale from the lender? Someone who could go all cash or qualify for a loan or borrow the majority of the funds from a hard money lender??

Yes, my brother in law is going to fund the deal with his cash, but has no interest in doing any of the contract work. He's my hard money lender.

Here's the simplest, most transparent way to handle this. Let your BIN be the purchaser. You,a realtor, or a short sale specialist negotiate the sale with the lender. All your BIN needs to do is finance the transaction. Next, you line up a purchaser for $140k. Once you have that buyer, your Roth, take an option on the property for $120 k. (I think that the option consideration should be greater than $10. Don't be a pig!). You then assign your option to the new buyer. At the closing, your BIN pockets 10K and your Roth pockets 20k. Everything complies with IRS regs. You repeat this cycle 5-6 times and you will not need any more financing from anyone.

Previously, it seemed that you wanted to do a simultaneous closing. I fear that when 120k goes into your Roth that you would have been penelized for an over contribution of $120k which would cause a whole host of penalties. Even a termination of your plan.

Also, the way you proposed to use your LT could cause problems if you intended to keep it in place-rather than terminate it upon resale. But, that's the subject for another post.