Self Directed IRA (Individual Retirment Account) Info
This page contains information that will teach you how to buy real estate using the funds in your individual retirement account (IRA). Most people don't know that IRA money can be used to purchase any qualified asset class. There are rules as to what you can and can't purchase. The publications on this page will teach you about these rules. As this is a legal but complicated transaction, we recommend that you consult a team of experts, namely your CPA and/or tax attorney, our preferred custodian of records, and of course a knowledgeable broker that will help manage the process.
We are confident that if you use us to help you benefit from these tools, then together we can make millions of extra dollars in your retirement account. In most cases we have found that we can help you increase the peformance of your accounts by 10% to 200%.
Of course, performance like this is not guaranteed. However, as real estate has outperformed almost all other asset classes over the last 40 years, we feel confident investing our own monies using the same strategies that we will share with you.
If you would like to know more, please call me for a free, no obligation consultation. I am looking forward to working with you and furthering your family's wealth through real estate investments.
The Basics
First, your IRA cannot be used to invest in life insurance, collectibles (e.g., artwork, antiques, gems, metals, and most coins) or S corporations. But you can invest in anything else, including real estate.
The possibility of real estate IRA investing has remarkable potential for those who are familiar with real estate investment, or who are associated with knowledgeable sponsors, advisors, or brokers. Diversifying your retirement portfolio with real estate investment can combat the pitfalls of longterm financial commitment, safeguarding against the changes that occur in the financial markets.
Real estate investors know that they can protect against the loss of principal while their real estate investment generates higher than market rate returns, through capital gains and income production. And when such leverage is not supplementing your real estate investments, income and capital gains can flow back into IRAs, with the tax deferred (or, if the IRA is a Roth IRA, there is no tax).
Easy
There are no special issues for those whose IRA-purchased real estate is paid for with cash, and purchased from an unrelated party, as long as you treat it like an investment, ie not for personal reasons.
More difficult
Certain restrictions apply if you use a down payment and leveraging to buy real estate with your IRA.
- A loan towards an IRA cannot be guaranteed by the IRA holder.
- Banks will be less inclined to lend money toward an IRA since the loan cannot be personally guaranteed.
- A portion of your IRA will be taxed as Unrelated Debt Financed Income (UDFI). An IRA is defined as a trust for tax purposes, and the trust tax rate will apply to income and/or capital gains made on the leveraged portion.
So it may not be desirable to have an IRA carry debt in a real estate investment transaction, even though it's perfectly legal.
What you can't do in an IRA with real estate
- Your IRA cannot buy real estate from a "disqualified person", whether directly or indirectly. So who is a disqualified person?
- The IRA owner;
- the IRA owner's spouse, descendant (e.g. son), or ascendant (e.g. mother);
- spouse of a descendant of the IRA holder;
- The IRA's trustee or custodian, as well as any other person providing services or acting as a fiduciary to the IRA;
- all entities under at least 50% ownership by disqualified persons. (eg: if your son or daugher owns 50% of a corporation, that corporation cannot sell real estate to your IRA);
- a highly paid employee, executive, or director of a disqualified entity, or a 10% owner of a disqualified entity.
- Your IRA can't be used to enable an investment for yourself or another disqualified person. So if the IRA's investment is essential to accomplishing a transaction in which both you and your IRA invest, then it's a prohibited transaction.
- As long as it is in the IRA, your real estate asset cannot be used by a disqualified person. You can't buy a vacation home and use it partly for personal use, and partly for renting to unrelated persons the rest of the year.
What you can do in an IRA with real estate
Now you know what designates a party as qualified or disqualified. The easiest way to use your IRA for buying real estate from a qualified person is to pay with cash. You can use the IRA for all kinds of investments - you can buy land, residential property for renting, commercial property, and real estate options. Your IRA can also extend loans (e.g., first and second mortgages) to unrelated parties.
As mentioned, you can also use your IRA to buy property through leveraging, as long as the loan is not guaranteed by the IRA owner (or any other disqualified person), and as long as the IRA is liquid enough to support the mortgage and expenses. Most custodians will only allow so much leverage. And leveraging can also result in income taxes on UDFI, payable by the IRA. You usually have to pay higher taxes on leveraging than you'd pay on income generated by a property that you purchase and finance personally. Moreover, the UDFI taxes must be paid from funds from the IRA and, therefore, there has to be enough liquidity in the IRA to cover these taxes. See IRS Form 990T and its accompanying instructions for details.
There are also options which don't require a full cash capital investment in order for an IRA to participate in real estate transactions. For example, your IRA could create an LLC with other parties to participate in real estate investing, or it could invest with other parties outside of an LLC.
Examples of real estate investments that can be made using IRA funds:
Example I
John's IRA has purchased a single family home from an unrelated seller. John now wishes to have the IRA sell it to his sister with a first mortgage that his IRA will hold.
Buying a single family home from an unrelated party isn't a problem. John pays $300,000 in cash and his IRA retains the grant deed from the third party's sale to his IRA. Later, John's IRA sells the property to John's sister and in exchange, it takes back a first mortgage and a down payment. She gets a market rate loan for 15 years and a 10% down payment. Since this is a $280,000 debt owed to the IRA and not by the IRA, there's no concern about the IRA's potential liability. There's a fixed income investment on John's IRA, protected because it holds the trust deed in case his sister defaults. The transaction can also have the incidental benefit of letting John's sister buy the home more easily than she could on the open market.
Example II
Allison wants to form an LLC that will buy property to be developed. She wants to make her IRA the primary investor, and she expects to have other investors in the LLC.
Allison's IRA can participate in the formation of the LLC, as long as Allison and related persons and parties do not already own 50% or more of the LLC in aggregate. If she has just formed the LLC, then the IRA can own something less than 100% (e.g., 85%). The LLC is considered to be a real estate operating company, so the assets are not considered plan assets unless the IRA owns 100%. If it's deemed that the company's assets are plan assets, then the company's treated like a disqualified person in the event of a transaction between the IRA owner and the company. Such a transaction is therefore quite possibly prohibited. Because of recent legal rulings involving self-dealing, we recommend you consult with an attorney if you intend to have a personal role in any entity in which your IRA is an investor.
If the LLC was not an operating company (for example, if it was a hedge fund), then the aggregate ownership of all IRAs and employee benefit plans would have to be less than 25% in order for the LLC's assets not to be considered IRA assets. (The interest owned by the IRA owner is disregarded for purposes of calculating the relevant percentage.)
Example III
Raymond wants to use his IRA to buy a $500,000 rental property. He also wants to make a 50% down payment. Can he do this, and what conditions apply?
Yes, this investment is possible, keeping in mind certain issues:
-The loan must be guaranteed by the property itself or property the IRA owns, and cannot by personally guaranteed by disqualified persons.
-UDFI taxes will be charged to the IRA. These taxes apply to any income and/or capital gains made on the leveraged portion of the investment.
However, if the IRA purchases a property with other parties paying cash, there are no UDFI taxes, and no special financing issues.
Conclusion
In summary, the tax laws (1) forbid the investments in an IRA from benefiting the IRA owner or other "disqualified persons" and (2) prevent "self-dealing" between the IRA and the IRA owner or other disqualified persons. However, by properly structuring an IRA investment in real estate, an IRA can obtain the benefits of real estate investment in a manner that complies with applicable tax laws.
( The foregoing is a general discussion. It is not intended, and should not be relied upon, as an opinion or advice on any legal, tax or investment aspects of IRAs. An IRA owner considering an IRA investment in real property should consult with his or her own advisor.)
