The stock market crash has left many people wondering where to invest. Depressed real estate prices present a unique opportunity for people with the real estate skills, who can judge risks and potential.
The idea of buying and selling in a market you understand is nothing new. As I perform title examinations, I often see in the books and pages at the Registry of Deeds how a real estate professional obtained ownership of a property, and then sold it for a profit after several years.
It's now time to consider using your skills in a way that will diversify and protect your retirement funds: The Self Directed IRA.
When real estate is purchased by a self-directed IRA, the IRA exchanges cash for the asset, the same as when you tell the custodian of an IRA at a brokerage house to exchange cash for shares of stock or a mutual fund.
Key points to remember for a self directed IRA investment in real estate:
● Rental income generated by the asset stays in the IRA, to cover asset expenses or earn interest;
● All expenses (taxes, repairs, maintenance) must be paid with the income from the asset income or with other funds in the IRA. Liquid funds to cover expenses must be available once the asset is in the IRA;
● Property taxes, mortgage interest, and depreciation cannot be charged against the value of an asset in the IRA and then distributed out to the IRA owner or beneficiaries. If the asset looses money, the loss cannot offset income from assets not inside the IRA. So, real estate skill and knowledge is required to select and manage a winning asset;
● After a traditional IRA sells the asset, the increase in value will be taxed as ordinary income (not capital gains income) when it is distributed to the IRA beneficiaries;
● After a Roth IRA sells an asset, the increase in value is tax free when distributed to beneficiaries.
Managing the asset owned by your IRA requires compliance with the IRS rules. You cannot rent the asset to your spouse, grandparents, parents, children, or grandchildren. That would be a "prohibited transaction." Any improper use of your IRA account by you, your beneficiary, or any disqualified person can cause a distribution of the asset, resulting in penalties, fees and loss of tax deferred status.
Disqualified persons include your IRA custodian and members of your family such as your spouse, ancestor, lineal descendant, and any spouse of a lineal descendant. While you can't buy an apartment house and then rent an apartment to member of your immediate family, you can rent the asset to your brother or sister while it's in your IRA.
The following are prohibited transactions:
● Borrowing money from the IRA
● Selling property to the IRA
● Receiving unreasonable compensation for managing the IRA
● Using the IRA as security for a loan
● Buying property with IRA funds, and making personal use (present or future) of the asset
Ownership of the asset must be held in the name of the IRA. Real estate in almost any form of ownership can be purchased by your IRA. Forms of ownership include fee title to the real estate, secured and unsecured notes, liens against real estate, C corporation stock, and ownership interests in limited liability companies (LLC), limited partnerships (LLP), and trusts.
The corporate, LLC, LLP and trust ownership form provide additional layers of asset protection.
Traditional banks and brokerages may be willing to serve as custodian for a self-directed IRA, but many of them limit your investment choices to products they sell. Companies that specialize in administering self-directed IRA accounts do allow you to direct the investment to land or buildings, and they provide the documentation that you need to comply with the IRS rules for a self directed IRA.
To avoid mistakes, keep a competent attorney and an accountant on your team to set up the ownership entity, and review the transactions.
Direct investment of some of your retirement funds in real estate, a market you understand, provides diversity for your overall retirement plan.
Click here for links to more resources on self directed IRA's.
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