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1. As a real estate professional, how can knowledge about self-directed IRA’s put money in my pocket?
For those of you who are investors, you can make other people aware that they actually have more money to invest in real estate than they thought since they can use their IRA’s to buy real estate. In other words, your knowledge of self-directed IRA’s can increase your pool of eligible buyers for your properties. Also, you can help others transfer their retirement funds into a self-directed IRA, then you can borrow those funds to make your own investments – in other words, you can create your own private bank! Finally, you can make your own retirement wealth grow with your knowledge and experience in real estate by buying and selling through your own self-directed IRA.
2. Is it really legal to buy real estate in your IRA?
Yes, absolutely! The Internal Revenue Code does not tell you what you can do with your IRA, only what you cannot do. Besides restrictions on purchasing life insurance and most collectibles in your IRA, nearly everything else is fair game. Unless your IRA is self-directed, however, your custodian may not allow investments in real estate.
2. Can I partner with my IRA or with other peoples IRA’s?
Your IRA can always partner with other people individually or with other people’s IRA’s. Under certain circumstances you personally may be able to partner with your IRA. However the burden of proving that you received no impermissible benefit from your IRA’s participation in the investment will be on you if the IRS ever questions the transaction. The transaction still must be an arms-length transaction, and the investment remains subject to the same restrictions as if the entire investment were in your IRA.
3. I only have a small IRA. How can I buy real estate?
There are at least 4 ways you can participate in real estate investment even with a small IRA. First, you can wholesale property. You simply put the contract in the name of your IRA instead of your name. The earnest money comes from the IRA. When you assign the contract, the assignment fee goes back into your IRA. If using a Roth IRA, this profit is tax-free forever!
Second, you can purchase an option on real estate, which then can be either exercised, assigned to a third party, or canceled for a fee. Third, you can purchase property in your IRA subject to existing financing or with a non-recourse loan from a bank, a hard money lender, a financial friend or a motivated seller. Profits from debt-financed property in your IRA may incur unrelated business income tax (UBIT), however. Finally, as mentioned above, your IRA can be a partner with other IRA or non-IRA investors.
4. Can an IRA buy debt-financed property?
Yes. Any debt must be non-recourse to the IRA and to any disqualified person. An IRA may have to pay UBIT on its profits from debt-financed property. In general, taxes must be paid on profits from an IRA-owned property that is debt-financed, including profits from the sale or disposition of the property, in the same proportion that it had debt. For example, if the IRA puts 50% down, then 50% of its profits above $1,000 will be taxable. Although at first this sounds terrible, in fact leverage can be an extremely powerful tool in building your retirement wealth. The same leverage principle applies inside or outside of your IRA. You can do more with debt-financing than you can without it.
5. Could my IRA be classified as a “dealer?”
It is possible that an IRA could be classified as a dealer. The same principles for determining whether you are a dealer personally also apply to your IRA. If the IRA is classified as a dealer, it would be considered to be running an unrelated trade or business, and the IRA would have to pay UBIT. Remember, it is not illegal to do things in your IRA that incur UBIT. Your IRA just has to pay taxes.
6. Can I sell a property I now own to my IRA?
No. Although the IRS has very few restrictions on the types of investments which are permissible in an IRA, there is a list of “disqualified persons” who are prohibited from dealing with your IRA or benefiting from its investments. The list of disqualified persons includes you, your spouse, your parents, your children, their spouses, certain business partners and key employees and persons providing services to your plan, among others. Interestingly enough, the definition of disqualified persons does NOT INCLUDE non-lineal descendants or ascendants, so if the transaction is an arms length transaction your IRA may be able to transact business with your brother or sister, aunt or uncle, cousins, etc. However, you should be aware that there is an element of danger in transacting business with any person in whom you may have an interest which affects your best judgment as a fiduciary of your IRA.
7. Can I receive a fee for managing property owned by my IRA?
No. The prohibited transaction rules are intended to make sure that you receive no current benefit from your IRA other than as the beneficiary of the IRA. Investments must be arms-length and exclusively for the benefit of your IRA.
8. If I am a Realtor, can I receive a commission for property bought or sold by my IRA?
No, for the same reasons stated in the prior answer. Anything that creates a possible conflict of interest with your IRA is likely to be a prohibited transaction. Why take money that is tax-free or tax-deferred and pay taxes on it now anyway?
9. Can I collect rents and do other management without compensation?
Most likely the answer is yes, although this has never been tested in court to our knowledge. An interesting question is how much can you do before your service to your IRA constitutes an excess contribution? In any event all checks must be made out directly to your IRA.
10. I like the sound of this, but can you give me specific, real life examples of what has been done in an Entrust self-directed IRA?
Example 1 – Wise Roth Conversion. Dapper Don has two Entrust self-directed IRA's a traditional IRA with money from his former employer's retirement plan and a Roth IRA. Don found a small piece of property in the country with a mobile home on it, which he could acquire for about $12,000. Don realizes the high profit potential of this transaction, but has insufficient funds in his Roth IRA to do the deal. Because Don will have modified adjusted gross income of less than $100,000 this year, he decided to convert $12,000 from his traditional IRA into his Roth IRA. Only seven weeks after his Roth IRA purchased the property, it was sold to the neighbor for $30,000. Although Don must pay income taxes on the $12,000 he converted from his traditional IRA to his Roth IRA, the $18,000 in profit from the transaction is TAX-FREE FOREVER!
Example 2 – Note Secured by Real Estate. Savvy Sam borrows money from Rich Rodney’s IRA at Entrust. Sam agrees to pay Rodney’s IRA 15% interest with no points and a 3 month minimum term on the loan. Before Sam can even finish the repairs, he gets an offer on the house. Sam accepts the offer, and they close within 6 weeks. Sam is ecstatic because he made $20,000 with no money from his pocket. Rich Rodney is very happy too because Sam paid his IRA 90 days of interest at 15% and only kept the money outstanding for 6 weeks!
Example 3 – Rehabbing a House. Rehabber Rhonda buys a house needing substantial repairs for $101,000 cash in her Entrust IRA. Rhonda spends approximately $30,000 from her IRA on the rehab. The property is sold in 6 months for $239,000. After the cost of the purchase, rehab, closing costs, holding costs and selling costs, Rhonda’s IRA nets approximately $94,000 on the deal.
Example 4 – Co-Investing With an IRA. Wise Wally invests $5,000 from his SEP IRA at Entrust and Wally’s father invests an additional $5,000 on a house purchased for $10,000 cash. Although the house could be called a junker, the rental income is $400 per month, which of course is split equally between Wally’s IRA and Wally’s father (the tenants send separate checks). Wally believes that eventually this neighborhood will be bought up by developers because of its location right on the lake. In the meantime, Wally expects to recover his acquisition expenses from the rental income in less than 3 years, even after payment of property taxes.
Example 5 – Purchase and Simultaneous Resale of Real Estate. Quick Quincy finds a commercial piece of land and puts it under contract in his Roth IRA for $500,000. Quincy’s IRA pays the earnest money. Quincy then contacts a major home improvement chain about buying the land. After some negotiation, the store chain and Quincy’s IRA agree to a sales price of $650,000. At closing, Quincy’s IRA buys the property from the seller and simultaneously sells the property to Barry’s retail store chain. Quincy’s Roth IRA nets approximately $146,000 after payment of closing costs.
Example 6 – Assignment of a Contract. Awesome Annie gets a contract on a burned out house in the Coverdell ESA of her daughter, Smart Sally, for $5,500 cash with a $100 earnest money deposit. Annie locates Investor Ingrid, who is willing to pay $14,000 for the house. Sally’s Coverdell ESA assigns the contract to Ingrid, and at closing Sally’s Coverdell ESA gets a check for $8,500.
Example 7 – Buying Real Estate With a Loan. Realtor Rose is a full-time real estate agent who at times purchases rental real estate for her own investment portfolio. Rose locates 2 properties that she wants to buy in her SEP IRA at Entrust. The houses Rose wants to buy cost about $210,000. Rose has a good relationship with a local bank, and they are willing to loan Rose’s IRA the money she needs with only 10% down on a 5 year, 6.5% interest, non-recourse note.
Example 8 – Buying Property Subject to a Lien. Fantastic Florence finds a property which is subject to nearly $100,000 in delinquent property taxes and is about to be foreclosed on by the taxing authorities. She contacts the owner and buys the property in her Roth IRA at Entrust for around $3,000 (including closing costs). The owner just wants to be rid of the headache. Florence’s IRA sells the property to an investor 3 1/2 months later and her IRA nets approximately $46,500 from the sale. Florence’s IRA will have to pay Unrelated Business Income Tax (UBIT) of about $13,500, but even after payment of taxes her IRA will be worth around $33,000 in only 3 1/2 months.
Investing in Real Estate
1. I’ve heard that buying and selling real estate in my self-directed retirement plan is illegal. Is this true?
Neither the IRS nor Department of Labor has ever published a list of legal investments. All investments are “legal” unless specifically prohibited, such as collectibles.
There is a list of prohibited transactions, disqualified persons, and collectibles on our site. Real estate and other investments are permitted, provided you follow applicable rules. These rules are spelled out in our book How to Invest in Real Estate and Pay Little or No Taxes, available in the Entrust Learning Center or book stores.
2. Can I buy real estate with a partner using my IRA?
You may have partners, including yourself and any family members, their IRAs, eligible 401(k) s or other qualified plans, when you purchase property using your IRA. Once the property is acquired with your IRA, you may not sell it to yourself or any family members. A family member consists of ascendants and descendants, or spouses thereof.
3. How do I actually buy real estate in my retirement plan?
4. What can I do if I don’t have enough money to buy real estate in my IRA?
There are several options:
5. Where can I get a loan to purchase real estate in my IRA?
Normally private lenders, seller carry-backs, and mortgage companies may lend to your IRA on a non-recourse basis. Sometimes banks and credit unions may make non-recourse portfolio loans to IRAs.
6. Can I buy property with my kids’ IRA?
Your children’s’ IRA may purchase property, and may do so as partners with your IRA, or any other IRA as noted previously.
7. Where can I go to learn about using my retirement funds for real estate investing?
8. Is there any liability to my retirement plan when it holds real estate?
You always face liability whether your plan is an IRA or qualified plan, such as a 401(k) plan. If, for example, your plan owns real estate and a person is injured on that property, the plan or IRA would have the same liability issues that you would have to deal with, if the property was owned personally.
You can protect your real estate IRA investment by doing the same things to protect it and your property, such as purchasing insurance, or by having your IRA create a limited liability company that purchases a 100% of the investment properly. Limiting liability for assets in your IRA or plan should be discussed with competent professionals, such as attorneys.
9. Can you finance a property that’s held in your IRA?
As noted above, you may have debt-financed property in your IRA. You may not use any asset in an IRA for collateral for a personal loan from which you would receive a current benefit. The IRS code is clear on this subject, and deals with debt-financed property under the Unrelated Business Income Tax rules.
10. How do I know if tenants are making payments on my account?
There are several things you can do:
11. What is UBIT?
The term UBIT stands for ‘Unrelated Business Income Tax’. UBIT applies to debt-financed property that you purchase in your IRA and also applies to operating income received from companies owned by IRAs and qualified plans.
If you purchase property with your IRA funds, and you finance some of the purchase through a loan, any income you receive is taxable under UBIT rules for the percentage of property that is debt-financed. The details can be found at www.irs.gov.
12. Can I pledge or hypothecate my plan to get more funds?
This is not permitted. Your plan may borrow money, however. The property purchased with borrowed funds will be subject to UBIT.
13. How do I buy foreclosed property using my Qualified Plan?
First, locate the piece of property you would like to purchase. You would negotiate the purchase price on the foreclosed piece of property with the lender, in the same way you would negotiate the price with any seller on any property. To purchase the property, complete a Buy Direction Letter to Entrust. This letter directs Entrust to purchase the property with your IRA funds. The plan makes the payment to the lender and the property is then vested in the name of the trustee of the plan for your benefit.
Pre-foreclosures are negotiated with the owner of the property, as in any property purchase. The debt is paid out of escrow, and the property is then placed in the qualified plan for your benefit, as above.
14. Can a company that I own rehabilitate or "fix up" property that I hold in my IRA or 401(k)?
Neither you nor a company you own, as specified in the prohibited transaction rules on our site, may provide any services to the assets in your IRA, which includes rehabilitating of “fix up” property, unless you first obtain a Prohibited Transaction Exemption from the US Department of Labor.
There are private letter rulings that have been obtained in the past, permitting latitude under certain circumstances. Private letter rulings may be obtained by application to the IRS.
There are also specific rules regarding taxation of prohibited transactions, which include a 100 percent tax if a prohibited transaction is not corrected in a taxable period, and a 15 percent tax on the amount of the prohibited transaction. Additional rules that disqualify the entire IRA apply to IRAs established by employers.
15. Can I invest my 401(k) in real estate?
Your 401(k) plan may, at your direction, invest in real estate if the investment provisions of the plan permit it. If the employer contributions to your plan have been made, and the plan permits self-directed investments, there will be rules to the amount you may invest from that portion you are vested in.
You may also have an Individual (k), which limit participants to owners only, plus spouses and partners, you may decide on the investments to be completely self-directed by you.
Remember that while Entrust provides excellent educational resources, we do not endorse or sell any investment products. The Entrust Group respects your privacy. Please read our Privacy Statement.
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