NUTS & BOLTS
REAL ESTATE & RETIREMENT
4Ways to Invest in Real Estate Using a Self- Directed IRA YOU HAVE PLENTY OF OPTIONS WHEN INVESTING USING YOUR IRA. ccording to the Investment Company Institute, there are $26 trillion in retirement plans in the United States. While the majority of those dollars are invested in the stock market, a significant amount is invested in real estate. Why real estate? Real estate can provide portfolio diversi- fication, has the potential to generate ongoing income, and is a tangible asset that is easier to understand for many people than stocks and bonds. Investors can use individual retirement account (IRA) dollars to fund real estate transactions, but only if their IRA is held by a custodian who permits self-directed investing. Tra- ditional custodians usually only allow investments into more “traditional” assets, like stocks and bonds. As a self-directed investor, you must learn and follow the rules governing self-directed IRAs, such as those dealing with prohibited transactions and self-dealing. One of the things investors like best about using an IRA to invest in real estate is the tax advantages that go along with it. For example, taxes associated with capital gains may be deferred until a distri- bution is made from a traditional IRA. In the case of a Roth IRA, account holders are not subject to taxes on distributions, including gains and profits generated by the sale of the property. Here are four common ways self-directed IRA investors hold real estate and gain those tax advantages in most cases: 1 DIRECT PURCHASE The IRA buys the entire property outright using funds in the account. The income and expenses (such as painting and repairs) flow directly in and out of the IRA or a segregated A by Chris Shanahan
SELF-DEALING: When a self-directed IRA investor takes
advantage of their position in a transaction to act for their own interests instead of those of the self-directed IRA.
TRM Note: It is a highly sensitive matter to combine your self-directed IRA funds with your own funds on the same deal. Work with an expert in this area to structure the deal, and obey every instruction to the letter. Failure to do this correctly can result in devastating fines, fees, and penalties. 3 LIMITED LIABILITY CORPORATION In these transactions, the property title is held in the name of the LLC. The self-directed IRA holds an interest in the LLC rather than title to the property. Buying real estate in a self-di- rected IRA using an LLC may provide those account holders with the protection of an LLC while giving them a bit more flexibility in terms of investing. An example: The LLC can buy and sell properties without having to go through the self-di- rected IRA custodian each time a transaction is made. 4 LEVERAGED PURCHASE In these purchases, as the name implies, the IRA borrows money to purchase property. There are important caveats with this option: a Neither the IRA nor the account owner can have any personal liability in the mortgage. Investors cannot back their own loans. b A non-recourse loan must be used so that the lender can
only seize the property being purchased and not the IRA owner’s assets or the rest of the self-directed IRA’s assets if the IRA defaults on the loan. TRM Note: Very few lenders will agree to make this type of loan. Even if you find one, have a lawyer review it to make sure that there is no language in the loan that negates the non-recourse. c All mortgage payments must be made with the self-directed IRA’s funds. d If property purchased in an IRA is financed by debt, income produced by that property, as well as the gain on any sale, could be subject to unrelated business income tax (UBIT). Of course, all investments come with their risks, and real estate is no different. It is crucial to conduct your due diligence and work with a financial professional whom you trust with experience holding real estate in an IRA before pursuing these opportunities with your retirement dollars. •
property management account established for the IRA by a property manager. 2 PARTNERSHIPS OR TENANTS-IN-COMMON PURCHASE These transactions combine the investor’s self-directed IRA funds with other investors’ funds or in conjunction with the owner’s non-IRA funds. The investment income and expenses are handled proportionate to each entity’s ownership amount. PROHIBITED TRANSACTION: Certain transactions within a retirement plan that violates Internal Revenue Code 4975. Prohibited transactions include, but not limited to, living, or utilizing the property owned by your IRA, using your IRA to buy property from a disqualified person, and creating a situation where you or a disqualified person to you receives a benefit of any kind (i.e. payment for a job, but the application is much broader) from your self- directed IRA.
Chris Shanahan is the director of investment review at PENSCO Trust Company and a certified IRA Services Professional through the American Bankers Association. He may be reached at takecontrol@pensco.com.
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