A friend of mine has a self-directed Roth IRA and a self-directed Traditional IRA, and he uses a combination of funds from both of them to buy, rehab, and then re-sell real estate (mostly single family homes, one or two a year) -- for a profit. The profits go back into his self-directed Roth and Traditional IRA's, and are either tax deferred or are tax free, depending on which IRA's the profits went back into.
I had a question and/or suggestion, and I am wondering if a future deal could be structured as follows to enable the profits to go disproportionately into the Roth rather than into the Traditional IRA.
Here's my example or suggestion using made up numbers:
The Roth has $10,000 in it, and the Traditional IRA has $90,000 in it. He buys the property in the name of the Roth for $50,000 and he has an additional $50,000 in expenses for repairs/rehab, holding costs, selling costs, etc.. So, the Roth needs a total of $100,000 to do the deal. The Roth puts up $10,000 to buy the property in the name of the Roth, and the Traditional IRA lends the Roth the remaining $90,000 at a modest but fair interest rate to pay for the purchase, repairs, etc. After all costs and expenses (including purchase price, holding costs, repairs/rehab, selling costs, and interest on the loan from the Traditional IRA to the Roth, etc), the Roth sells the property for $130,000 -- a $30,000 profit.
My question is, can the deal be done like this, where the entire $30,000 profit goes to the Roth, even though the Roth only put up $10,000 of the total cost of the project?
If so, all of the $30,000 profit would go into the Roth and would be tax free.
The Traditional IRA would earn some interest on the loan to the Roth, which would go back into the Traditional IRA and would be tax deferred. But, since the Traditional IRA did not own the property -- it only loaned money to the Roth -- the profit from the re-sale would all go to the Roth as the owner of the property.
Is this correct, or am I missing something here?
The alternative, which is how he is doing it now, would be for the Roth and the Traditional to be partners in the purchase with a $10,000/$90,000 split according to their contributions to the deal, and the profits being split
1/10 back into the Roth and 9/10 back into the Traditional IRA. But, that would mean that most of the gains from the sale would be tax deferred rather than tax free.