Entrust Learning Center > 3. Investment Options > Real Estate as a Pension Plan Investment

Real Estate as a Pension Plan Investment

Since 1975, real estate professionals were among the first to use their "Keogh" plans (now called Qualified Plans) to purchase real estate investments.

By: Hugh Bromma

The dollar amounts that could be contributed then were more (eight times more) than one could put into IRAs, so the Keoghs were the natural place for such contributions.

The flexibility of the Keogh as a self-directed, tax-deferred vehicle for investment property has not changed in 30 years. Even IRAs became popular with the Simplified Employee Pension Plan having the same contribution limits as Keoghs. The Roth IRA in 1997 and especially the Roth 401(k) (which has no salary caps for deferrals) in 2006 made tax-free investments phenomenally popular.

The methodology was and is straightforward: there is a trustee for both qualified plans and IRAs. The trustee for qualified plans can be the employer, the IRA trustee or custodian must be an institution, such as a bank. In both cases, the accounts established are tax free until withdrawn, and tax free forever for the Roth versions.

Doing the math is essential. The real estate professional does math daily. The math has not changed much over the last 30 years either. Tax code changes have been legion. When you look at the possibilities of the investment you make in real estate, there are effectively four major alternatives:

• Investments taking advantage of tax write offs personally
• Investments using tax-deferred accounts
• Investments using tax-free accounts
• Investments using tax-deferred exchanges

Take these four alternatives and add the factor of debt financing, and there are eight possibilities with different tax consequences.

Real estate investors in our experience have done the calculations in one way or another suiting their personal circumstances over the last 30 years. The results stack up as follows:

• The assumptions using the same dollar amount invested identical cash flow, and a 10-year time horizon for the sale of a property.
• For all cash transactions, almost invariably the Roth account is the best alternative in the long run, even beyond 10 years. The traditional IRA and Qualified plan (Keogh, 401(k), etc.) have distribution requirements at age 70, otherwise the result at 10 years is no tax on an all-cash transaction.
• 1031 exchanges and individual returns as far as taxes payable, come in third and fourth. The individual return pays tax of more than twice as much in an average transaction than a 1031.

For this reason, our real estate investor professional likes the all-cash transaction best in a tax-free and then tax-deferred investment over the long haul. When a real estate asset investment property is debt financed, the results are very different, and are dependent on the amount of debt financing involved, recognizing that unrelated business income tax rules apply (Unrelated Debt Financed Income tax for debt) for IRAs. At a 70% loan-to-value ratio using IRAs only, the results show 1031 Exchanges are the least taxed, followed by the IRAs, and then personally invested dollars. Of the two IRAs, the Roth is more advantaged, as the traditional IRA starts paying tax at required distribution starting at age 70, where the Roth doesn't get taxed again. At 40% loan to value, the IRAs come in better than 1031 exchanges.

Acquisition debt in a qualified plan is not subject to such tax, making the qualified plan the best place to invest in property that has debt finance. The results are like cash. No tax until withdrawals are made at age 70, but then there is the added advantage of the Roth portion never being taxed again.

For over 30 years the advantage of tax deferred investing has been available to everyone who earns income. Real estate professionals were there at the beginning and are even measured in stronger numbers today. As self-directed plans become more popular, and the tax laws become more sophisticated, the professional measures each situation and comes up with the best result.

Each is different for everyone, and we suggest that by using a local professional familiar with the investments you make, along with your professional team of administrators, advisors, attorneys, financial planners and accountants, you will make the best decisions.

Hugh Bromma is the CEO of The Entrust Group, one of the largest administrators of "non-traditional" retirement assets.

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