IRA Real Estate Investing
Diversify the investment options in your IRA to maximize earnings. Real Estate is a great way to do this!
Can I really invest my retirement assets in real estate? / Absolutely! In 1974, the Employee Retirement Income Security Act (ERISA) gave all self-directed retirement plans this option. In addition to real estate, you can direct your IRA investments into - among other things - mortgages, notes, tax liens, and private businesses. There are, of course, restrictions on some investments.Why haven't I heard about this opportunity before? / Brokerage companies earn commissions when you buy and sell stocks, bonds, and mutual funds. They don't make money when you buy real estate. Further, very few banks or trust companies are interested in holding “non-traditional” assets they don't understand. Only a small handful of companies that provide “full service” to self-directed retirement plan beneficiaries.
Are there any pitfalls to self-directed plans? / There are many potential pitfalls with respect to both prohibited transactions and timely reporting at the state and federal levels. For example, engaging in a “prohibited transaction” can cause the favorable tax status of your IRA to be forfeited. Structuring transactions in ‘safe harbors' avoid such problems and ensure statutory compliance.
Who makes the plan's investment decisions? / You make the investment decisions for your retirement assets in much the same way as you invest outside of your retirement plan. But you don't invest alone. Certain “Trust” companies will help you navigate the complex rules that govern prohibited transactions so you can focus on making the best investment decisions.
How are my assets managed? / Your assets are co-managed by you and the “Trust” company. You make all investment decisions, and they take care of all of the paperwork and the reporting details. Once you make an investment, they will keep your books and records, coordinate the custodianship of your assets, oversee the annual asset valuation, and file all required annual reports.
How to Expand your Real Estate Buying Power
Using Debt to Purchase Real Estate / Your IRA can employ the use of debt to finance the purchase of real estate, but there are some rules to follow. First, the loan must be non-recourse, which means that you may not personally guarantee it. Second, in order to avoid potential penalties, only the assets of your IRA may be used to make the loan payments. Finally, you cannot use your own credit history to obtain the loan. The real estate purchased by your IRA is the only asset that a lender may use as security for the loan. Another popular financing option is to have the seller of the real estate take back a note at the time of sale. Real estate purchased with debt financing is subject to the Unrelated Debt Financed Income (UDFI) tax.
UDFI and UBIT / Unrelated Debt Financed Income (UDFI) and Unrelated Business Income Tax (UBIT) are areas of the tax law that can impact your IRA investments. UDFI is most commonly triggered when your IRA utilizes debt to finance the purchase of real estate, but any income produced by the borrowings of your IRA can also generate UDFI. The tax is based on the net income attributable to the debt on an annual basis. For example, IRA real estate purchased 50% with debt and netting $10,000 in a year has $5,000 in UDFI that is subject to tax. The tax resulting from UDFI must be paid from assets in your IRA. There are some exemptions from UDFI and some strategies you can use to reduce or eliminate the potential for tax. UBIT works in a way similar to UDFI, but the tax is triggered by the investment made and the type of income generated by the investment. UBIT is a complicated area of the tax law and we suggest that you consult with your tax advisor for guidance.
Investment Options
The most important aspect of a self-directed retirement account is the ability to truly diversify your retirement assets. The following investments are just a sample of the opportunities available to you.
Real EstateRaw land
Building lots
Single-family homes
Multi-family homes
Vacation property
Contracts for sale
Lease options /
More and more people are investing their retirement funds in real estate. These people have enjoyed both income and capital appreciation while diversifying their retirement portfolios and increasing control over their investments. You can invest in all types of real estate, residential or commercial, from raw land to single-family or multi-family homes, from building lots to vacation property, and even contracts for sale and lease options. You can use cash for the purchase, or you can employ a combination of cash and debt financing. If a project is too large for you to complete on your own, we can help you to combine your IRA money with other people’s IRA money and other people’s non-IRA money. Be sure to check our prohibited transactions section for some transactions you should avoid.
Loans
Mortgages
Business
Construction
Auto
Personal
Unsecured /
One of the best ways to get started with your self-directed account is to invest in loans. Developing your own loan portfolio is an exceptional way to diversify and control your income-producing investments. This is a natural fit for a mortgage broker or a loan officer, but anyone with a self-directed account can make loans. You can lend money to businesses and individuals on a secured or unsecured basis. You can finance the purchase of a home, an automobile, or even manufacturing equipment for a business. You can lend money to a builder who is constructing a house, using the land and home as collateral. You can even factor receivables and finance commissions. The possibilities are almost endless!
Private Business
“C” corporations
Limited Liability companies
Partnerships
Private debt placements /
Small businesses are the backbone of the United States economy and investing in them is an option for your retirement plan. All around us, people are raising money to start, grow, or buy a business and your IRA can participate. Your IRA can invest in all different types of businesses, including “C” corporations, limited liability companies, partnerships, hedge funds, and private debt placements. About the only option unavailable to your IRA are shares of an “S” corporation. “S” corporations have to give up their favorable tax status if they accept IRA investments. Investing in private businesses presents a great growth opportunity for your retirement portfolio. As with any growth-type investment, this area comes with its share of risks, and the rules governing prohibited transactions must be followed.
Brokerage Accounts
Stocks
Bonds
Mutual funds
Futures
Options
Commodities /
Brokerage accounts allow you to buy and sell publicly traded stocks, bonds, and mutual funds of your choosing with your IRA money. However, the brokerage companies restrict the trading of futures, options, and commodities markets in your IRA. If you are experienced in these markets and know how to trade them for profit, you’re typically locked out of them for retirement investing.
Self Directed Education
What is an IRA? / An IRA is a personal savings plan that gives you tax advantages for setting aside money for retirement. Provided you meet certain income guidelines, a Traditional IRA allows you to deduct your contribution in the tax year it is made, and investment earnings accumulate tax deferred. Upon reaching retirement age (59½ years old), distributions are treated as ordinary income. If you take a distribution before reaching retirement age, you will incur a 10% penalty as well as federal and state income taxes. You must begin taking distributions at age 70½.What is different about a Roth IRA? / Contributions to a Roth IRA are made on an after-tax basis, meaning that contributions to your Roth IRA are not deductible. However, investment earnings accumulate without tax and once you have reached retirement age distributions are tax-free. Also, there are no mandatory distribution requirements with a Roth IRA.
How much can I contribute to my IRA? / Subject to some income limits, you may contribute up to $4,000 in the 2005 tax year to either your Traditional or Roth IRA. If you are 50 years old or older, you may contribute up to $4,500.
What types of accounts can I rollover into my IRA? / Among others, you may rollover a Traditional IRA, Roth IRA, SEP IRA, 401k, or 403b. In addition, you may consolidate multiple retirement accounts into one IRA. For example, if you have two 401k accounts open with former employers and an IRA, you may rollover all three accounts into one self-directed IRA.
Are there any investments that I can’t make with my self-directed IRA? / You cannot invest in Life Insurance Contracts or Collectibles (as defined by the IRS). Also, you may not participate in prohibited transactions. As an IRA owner, if you violate these rules, you could forfeit your entire IRA. It is crucial that you work with competent advisors to help you avoid these transactions.
What exactly is a prohibited transaction? / IRA transactions must be for the exclusive benefit of the retirement plan and must not directly or indirectly benefit the IRA owner, or certain other “disqualified” people. Therefore, prohibited transactions are those involving your IRA and a disqualified person. “You” are a disqualified person, as are some of your family members, some businesses that you or your family members own, and fiduciaries of your plan. You IRA may not make loans to any disqualified person, you cannot extend credit to your IRA, and you cannot pledge the assets of your IRA to secure a loan. By way of examples, your IRA may not purchase the home in which you live, your IRA may not rent real estate it owns to your children, and you cannot personally guarantee a loan that your IRA uses to finance the purchase of real estate.
However, there are many details about prohibited transactions and there are many exemptions to the rules. Security Trust Company can help you navigate these complex rules and keep your plan in compliance.
Penalties / The penalties for failing to comply with the rules can be severe. They range from a penalty tax to forfeiture of your entire IRA. To develop a true understanding, let’s invent a hypothetical prohibited transaction. Assume you have an expensive penthouse in New York City that you are renting to your son while he attends college. The IRS sends you a notice explaining that you are involved in a prohibited transaction and gives you the opportunity to correct the situation. You find your son a new apartment and get a new, unrelated tenant for your penthouse. The IRS can impose a penalty tax on the amount it determines to be subject to a prohibited transaction.
Assume the same set of circumstances, but in this case you ignore the IRS’ notice and continue to let your son rent the penthouse. The IRS will send you a notice stating that your failure to comply has resulted in the forfeiture of your penthouse. The IRS seizes your real estate, removes your son from it, and sells the property. The proceeds of the sale go into the US Treasury and your once-substantial IRA is now gone. The best way to avoid this type of situation is to make sure you have a solid team of advisors helping you navigate the process.
Federal Statutory Regulations / IRS Links
Individual Retirement Arrangements
Retirement Plans for Small Business
US Department of Labor Links
SEP-IRA’s
Michael Valdes
Realtor/ Mortgage Broker
Keller Williams Realty/ GEL
(813) 294-5626 Direct
The Florida Property Finder website and Michael Valdes are only providing this information as a service to their customers and do not claim any responsibility for this reports inaccuracy or content, nor to be considered an IRA trust expert.
1