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Winning Strategy: Using Your Self-Directed IRA To Purchase Real Estate Investment Property

By Chris Lengquist

Real Estate Agent with Ad Astra Realty BR00222587

May 22, 2007 04:19 PM

palm tree Are you using a self directed IRA to purchase real estate investment property?

If not, you really need to hunker down and wade through this posting. It could be the difference between retirement and a retirement worth having.

Understanding Your Investment Dollar

Most people in America today have no real understanding of their financial situation. That's not insulting you. It's just the truth. And here is a perfect example.

Example: A fresh out of college graduate takes on his first job and immediately begins making more money than he has ever had before. He feels kinda guilty about spending all that money on just cars, music and entertainment so he pays heed to the guy sitting next to him in the office and sets up an IRA. Immediately he begins contributing to the IRA and maxes out his contributions each and every year. (Which for 2007 is $4,000.)

Years pass by, the young worker has gotten married, kids have come along and there are now bills to pay and responsibilities to respond to. He still maxes out the IRA contribution and feels great that he has been doing this for fifteen years. From humble beginnings has sprung a very healthy chunk of money. "It's worked great so far" he says to himself as he decides to just keep doing what he's doing. After all, he is so far ahead of most of America that it really isn't funny.

To this point our example man has had his IRA invested in stocks, bonds or certificates of deposit his investment broker recommended to him when he opened the account. Do you think the investment broker ever told him he had a choice when it came to where his IRA invested? I doubt it.

Now that the example man has some money, real money, built up in his account he may want to start seeking professional help as how to expand the earnings of his investment. And one avenue that deserves serious exploration is the use of a self directed individual retirement account to purchase investment real estate.

Exactly What Is A Self Directed Real Estate IRA?

Great question! Most IRAs are limited as to their investment scope. An IRA may say that it is self-directed, but the self direction is limited to stocks, bonds, annuities and the like and could be even further limited as to the fund your investment counselor is tied in with.

A true Self Directed IRA is an IRA that allows you to invest in:

Traditional vehicles like stocks, bonds, annuities, bank certificates, etc.
Real estate
Private Limited Partnerships
Commercial property
Accounts receivable...and more

I could sit here and type up a beautiful dissertation on the exact ins and outs of the SD-IRA but there is a company out there that has an outstanding website on the subject explaining the benefits, prohibitions and boundaries of the SD-IRA. I would strongly encourage you to visit Equity Trust Company to read more in detail about this subject. Here are a list of links that will help you to research the topic more thoroughly from an investment real estate standpoint.

Now, if you have actually taken the time to read through these links I've provided you might be saying "Whoa!" good or "Whoa!" bad. As you may have noticed there are great rewards to be had by purchasing and holding real estate within your IRA. There are also disastrous consequences to not following each and every rule to the letter. Those of you that know me well know I like to present both sides so that you can make your own decision!

With All The Procedural Risks of Real Estate Inside an IRA, Why Would I Do It?

Quite simply, the returns, man.

Listen. You are after a retirement worth having. Right? You Stocks and bonds have been returning you an average of 5%-8% per year. (Actually, mine have been considerably below 8%, or 5% for that matter. But that's a whole other post!) And that's not bad. But what if you had a $150,000 house in Kansas City that your IRA owned?

Appreciation would be the historical 5% a year over any given 10 year period. Not a guarantee, just using past performance to gauge.
All the rent money you collected would go right back into your IRA. Let us start with rents at $1125/mo with a 3% per year elevator and a 5% overall vacancy rate.
Using those two income sources only (because you cannot depreciate real estate inside an IRA nor can you deduct interest if there is a debt instrument) that $150,000 would be worth $389,800 at the 10 year mark.
If you had kept the $150,000 in the stock market averaging 8% a year the value of that money would now be $323,839.

Obviously, both had fees within them that haven't been discussed in great detail. And those fees would have a bearing on what the exact returns would be. But I challenge you to research those on your own and see what the results would be. You may very well be surprised, yet again. champagne

And what about upside? It is possible to choose a stock or mutual fund that will outperform the rest of the market. It is also very possible to find one that doesn't. Over time, it is my belief that from a greatest appreciation rate view that real estate will win over any stock.

This blog and this real estate agent does not endorse a complete liquidation of all your stock, bonds and mutual funds as an investment strategy. I do, however, endorse the diversification of your investment holdings to include at least some income property. Real estate has proven to be at least as effective as traditional investments. Use that to your advantage to create your retirement worth having.

There are also other ways you can use your IRA to benefit your earnings growth. You could buy a house, rehab it and sell it with all the profits being returned to the IRA. Again, there are VERY stringent rules you would have to follow so as to not void the integrity of the IRA. But a $24,000 contribution from an investment would far surpass the currently maxed out contribution of $4,000 per year. Right?

Hopefully, this blog post will get you to thinking more about your investments and your retirement. If it has done nothing more than that it has succeeded. And if the idea of using an under-performing IRA to speed along that anticipated day of freedom sparks and interest in you hopefully you will contact the necessary professionals to discuss whether or not it is right for you.

For any specific questions or concerns regarding this post, fee free to contact me at listwithchris@kw.com. I look forward to hearing from you.

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Thesa Chambers

West + Main - Bend, OR

Principal Broker - Licensed in Oregon

I actually have a client that has purchased 3 homes with me this exact way.... it is pretty cool - a little cumbersome with additional paperwork but hey it works

May 22, 2007 07:10 PM

Anonymous

Rob

We use PENSCO Trust Company, and they really do a great job. The paperwork is made really easy. They also have a ton of free education classes that you can attend and their website is easy too. www.penscotrust.com

May 23, 2007 03:40 AM

Chris Lengquist

Ad Astra Realty - Olathe, KS

Kansas City Real Estate Investing

Thesa, it is a largely unknown, misunderstood way of financing the funds. I've heard people saying they do things that would definitely void the integrity if the IRS knew. But a great repeat source if used correctly!

Rob, thanks for sharing. I've heard great things about PENSCO, as well. There is another one out there and I think their name is Ohio Trust. I've heard a couple of people mention their name.

May 23, 2007 03:49 AM

Rod Pierson

Wilson Realty Inc - Redding, CA

Northern California - An Agent you can trust

Chris, great point.......... this is such a great way to invest for your future, most people don't think out of the box, and certainly your stock broker or financial estate planner won't tell you since they want you to invest with them. The article above about purchasing a primary property with your IRA and living in it definitely defies the rules of the IRS. You can however pay to have a LLC created and have the LLC purchase the property and them have the IRA own the LLC, this is a totally legal way to occupy a vacation property and or let family stay in the vacation house. Also good for asset protection. Another good SD -IRA custodial company is Entrust.

The real sad part about your first senario about the young man purchasing and contributing to his IRA is that even at eight percent and with the IRS rules of contributions it won't add up to enough to actually retire and take a monthly withdraw, eventually the IRA will get below an amount to keep producing income. The IRS has it all figured out, by the time you pay the deferred taxes you are not left with enough, no one knows what the magic number is for a retirement. Now if the young man had the option to do a Roth IRA and then later did a self directed IRA and invested in a well producing income property he might have a chance to retire.

As self employed individuals, most of us haven't even had the opportunity to put away for a SEP. or other form of retirement. It is so sad I know alot of smart well educated people and they have a nice home, nice cars, all the toys and are mortgaged up to debt with no savings, no retirement and now approaching fifty five. They tell me that their social security will be there for their retirement, actually they must be waiting for a large inheritance.

The problem with the generic IRA is just what you said early in your post, the broker does not tell there investor what their choices are, and supprising enough alot of brokers don't even know all the ins and outs of the self directed IRA's that have been available since 1975 to purchase real estate. Granted the Roth IRA is not as old as the original IRA.

In 2010 you can convert your IRA to a Roth IRA and have two years to pay the taxes, if a person could afford to do this, when they purchase an income property, they will not owe the deferred taxes when they make withdrawls after fifty nine and half.

I started to do a series on this type of investing for retirement and didn't get many comments on my introductory article so I am not sure I will waste my time do a series on this subject. As you know there are so many ways to prepare for your retirement....... and thinking out of the box is the only way it will really pay off.

Did you know you can also contribute your own funds with IRA funds to make a purchase, along with using up to fifty percent loan to value non recourse loans. Which is a great way to leverage your Real Estate investments.

As you know there are specific rules and it is easy to jeopardize you IRA, it is not for the weak and mild..... but for someone who understands Real Estate. I was told several times all my retirement is top heavy in Real Estate........ but look what our market did to us the last two years.... and now with the hearings going on.... Wall Street is not happy...

What is going to happen when the Europeans pull out of our bond markets after this Volcano and go back to investing their money in their own bond markets, and the government is no longer supporting the bond market...... stocks fluctuate up and down and most of the brokers get theirs off the top before it crashes like Merril Lynch last year. Now Real Estate on the other hand has never been seen at Zero value like stocks. Real Estate historically appreciates roughly at three to five percent a year depending on location etc. I would rather take my chances and put all my retirement money in Real Estate, you can diversify and buy commercial income and vacation income property.

I might have got a little long winded since I have done so much research and don't feel that the conventional way of investing is safe for the long haul.

As for anything in this post, I am not an expert and all my information has been extracted for actual personal evaluation, I recommend anyone who wants to investigate further to talk to one of the companies that have been listed in the this post and other post, or search for your own Self Directed Custodian.

I appreciate any feed back this is a very wide subject and there are many rules and regulations to follow. I am sure most of these rules and regulations have been created by the attorneys and congressman for their own personal gain and have made the rules so difficult to follow that a specialist is required to take full benefit of this type of investing.

Apr 28, 2010 05:31 PM