Using Your IRA to Purchase Real Estate

By
Real Estate Agent with Dean & Leininger of Kalispell

With the stock market in the state it is in lately many people have been looking for alternatives. Well, since I am in real estate and real estate is what I know and trust we have looked into purchasing real estate using your IRA and have been very successful at it. To get us started I have below some of the most common questions people ask.

Questions and Answers

Using Your IRA to Purchase Real Estate

 

 

What is a Self-Directed IRA?

A self-directed IRA is legally no different from any other IRA. The term "self-directed" simply means that you, the client, choose your IRA's investments. What this means for you is MORE CHOICES & MORE FLEXIBILITY for your retirement savings plan.

 

What can a Self-Directed IRA invest in?

The rules governing what and IRA CAN invest in are exclusive - not inclusive. The rules only specify what you CANNOT invest in. Therefore there is an unlimited array of possible investments that fall within the permissible boundaries. The IRS defines that the following assets are EXCLUDED

            Life Insurance contracts (e.g. a life insurance policy on the life of the IRA owner)

            Collectibles (e.g. antique rugs, cars, stamps, furniture, etc.)

            Capital stock in an "S" corporation

 

Can I buy real estate using my IRA?

Yes! You can buy real estate with your IRA, Roth IRA, Sep/IRA, Educational Savings Account, or 401-K, 403b, 457, ESOP, and other pension plan rollover accounts. Imagine not being confined to investing your hard earned money in the volatile stock market or limited return CDs. Your IRA can purchase raw land, rental properties, commercial property, condominiums, mobile homes, boat slips, and foreign real estate

 

How do I buy real estate with my IRA?

You will need to transfer your existing IRA(s) or rollover your pension plan accounts to a trust company that will allow you to direct what your IRA buys. Then you just find property and go through the steps of each trust company.

 

Why haven't I heard of this before?

The fact is that you have been able to buy real estate within your IRA since the first day IRAs were created 31 years ago. You haven't heard of it because until recently, the use of IRAs and other retirement plans to purchase real estate was an option that was not well known. Most custodians do not offer truly self-directed IRAs. They will allow you to invest in their approved list of investment options. The reason being, Brokers are compensated when they sell stocks, bonds and mutual funds. Therefore they are not trained in the details of performing real estate transactions.

 

How do I know that this is all legal?

You can go to the IRS website and search for Publication 590 which is the section which defines everything the IRS wants you to know about IRAs. It tells you what you CANNOT do within an IRA. You will notice that real estate is NOT mentioned as one of the asset types in which an IRA is prohibited from investing. There IS mention that you cannot borrow from an IRA or use an IRA as collateral for a loan. Because that would be a prohibited transaction, many have felt that real estate investing would be a problem. BUYING REAL ESTATE IN AN IRA IS PERFECTLY LEGAL AS LONG AS YOU AVOID SOME KEY PROHIBITED TRANSACTIONS.

 

Are there any downsides?

There are not any downsides per se, other than the fact that there are certain types of transactions that you cannot enact through an IRA, i.e. prohibited transaction.

 

How do I take funds out of my IRA to buy real estate, without paying taxes and penalties?

YOU DON'T take the funds out. Buying a 100 acres of ranch land in eastern Montana is the same as buying 100 shares of IBM stock. Buying real estate is just like a purchase of a different type of investment.

 

Can I use my IRA for a down payment?

Yes, in many cases you can. On the other hand, there are important rules and potential consequences that have to be considered when you do. One of the prohibited transactions for an IRA is to serve as collateral for your loan. Essentially, what this means it hat your IRA, by virtue of it being a down payment on your real estate purchase, would be serving as collateral for your loan to buy the property, whether you take the loan solely or guarantee it for your IRA.

 

So, I thought you said I could use my IRA for a down payment?

Your IRA can obtain a "non-recourse loan" when it puts a down payment on a purchase, and then finances or leverages the balance by taking out a loan or mortgage for the difference between the deposit amount and the purchase price. "Non-recourse" means that the only choice the lender has in the event of a loan default is to take back the property and sell it. Banks will generally require 30-35%+ down for a non-recourse loan to an IRA.

 

Are there alternatives to a commercial non-recourse loan?

A seller of a property can also extend a loan to an IRA by offering what is called a "seller carry-back loan", eliminating the need for a bank loan. This can work to your advantage because a seller may be willing to accept less money down if they want to sell badly.

 

Do I have any other options if my IRA doesn't have enough money, and I can't get a non-recourse loan?

Absolutely. You can partner with your IRA and combine your IRA funds with your personal funds to make an all cash purchase. Don't have enough cash? You can combine your IRA and personal funds with your wife's or husband's savings, her or his IRA, funds from your friends, children or other relatives in order to enter into the transaction together as tenants-in-common. Each investor appears on the grant deed as a percentage owner, based on the amount of each investor's contribution.

 

If I buy rental property with my IRA can I manage it?

Yes and no. You CAN perform ministerial functions for your property much as you would for any other asset. This could include making decisions such as to whom to rent, what plumber to contract with or what builder to choose when you make additions. You will have to instruct your trust company to pay these bills because you cannot pay them yourself. You cannot build a porch yourself, put on a new roof, etc. or in general add any material value to your property through transactions with it. It is a very thin line to walk and many people agree that it is better to be safe than sorry and hire professional management of your rental properties.

 

I plan on purchasing a property with my IRA that will generate rental income. Does the rental income have to go back to my IRA?

Yes, all income generated by a property owned by your IRA must be returned to your IRA, in order to retain the tax deferred or tax free status of the investment.

 

Can my IRA purchase real estate that I own presently?

No. This is considered a prohibited transaction. You may not purchase a property or interest in a property, which is presently owned by a disqualified person. Disqualified persons would include yourself and family members of linear descent.

 

May I live or work in a property that my IRA owns?

No. This is considered a prohibited transaction. You cannot have any personal use or benefit from the property while it is held by your IRA. This means you can't purchase your residence, time share or lake property that you intend to use during the summer and rent the rest of ht year. If you purchase a rental property, the tenants cannot be disqualified persons under Section 975 of the IRS Code. Disqualified persons are generally those of lineal descent of the account holder or the account holder's spouse.

 

Can my IRA invest in a newly formed entity (limited partnership, limited liability company, c-corporation, land trust) that will be involved in real estate?

Investments in newly formed private entities are not prohibited, with the exception of sub chapter S corporations.

 

 

May I use finds from my IRA to renovate property in order to sell it at a higher price?

Yes. Your IRA must pay any and all expenses (property taxes, insurance, appraisals, debt payments, etc.) associated with a property that is owned including renovation, improvement, and repair costs of the property. All profits that are associated with your IRAs investment in a renovated property must be remitted to your IRA.

 

Why should I use a Roth IRA for real estate investing?

IF you invest with your Roth IRA (and by the way, your Roth, SEP and regular IRA can all invest together in a real estate investment as tenants-in-common), all the income and capital gains will go back to your Roth IRA tax deferred. Because Roth IRAs are funded with after tax funds, if you leave the earning in the Roth for five years from the date the Roth was first established AND until you are 59 ½ the entire Roth INCLUDING THE EARNINGS, WILL BE TAX FREE FOREVER!

 

Can I buy a business using my IRA funds?

Yes. Few people realize that you can buy and operate a business with an IRA. Some people with full-time jobs will establish a new business just for their IRA account. Such businesses, whether they buy real estate or operate a gas station, restaurant or dry cleaner, are called operating companies where they provide goods and/or services. When your IRA owns and operates a business, it is subject to taxation just like any other business. Otherwise, the IRS says, the IRA could provide unfair competition to those businesses that have to pay those taxes. This tax is called Unrelated Business Income Tax (UBIT) - "unrelated" because and IRA is a tax-exempt entity.

 

Can my IRA invest in my existing business?

Yes. Let's suppose you are an owner of a company that is willing to take on additional capital. If the company is an "operating company" as discussed above, AND you own less than 50% (including the sum of the ownership positions of your "disqualified persons"), then your IRA can invest funds in the company if it is a good investment for the IRA and not made to protect your non-IRA interests.

 

Now that I know what I can and cannot do with a self directed IRA, where can I get one?

There are approximately 20 custodians in the United States that are dedicated to providing self-directed IRA services.

 

As always call with any questions. 406-253-0531.

 

Have a great 4th of July!

Comments (1)

Anonymous
Mark Adams
You can get more information on the self directed IRA rules by visiting http://iracheckbook.com or getting a free email crash course on the 5 things you need to know about the self directed IRA. https://www.getdrip.com/forms/2268282/submissions/new
Feb 21, 2014 02:08 PM
#1