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Put Savings to Work: Self-Directed Retirement Accounts Broaden Your Options

By: Hugh Bromma

IRA Insights

By Hugh Bromma

You’re doing all the right things in saving for retirement: setting up IRAs, SEPs and investing in stocks or annuities. You can take your planning one step further with a self-directed retirement account. They not only offer greater diversification for your savings portfolio, but also provide another source of capital for real estate investments.

Self-directed arrangements have been around for 30 years and offer the same tax advantages as traditional IRAs and other retirement plans. The difference is that self-directed accounts allow account holders to direct their own investments.

To get started, you’ll need to either create a self-directed account or convert an existing retirement arrangement. A third-party administrator or trustee who offers self-directed arrangements can help you facilitate any rollovers or transfers and handle all record keeping, administration, and government reporting requirements. There are about a dozen companies nationwide that offer these services, including Entrust Administration Inc., Oakland, Calif.; Sterling Trust Co., Waco, Texas; Trustar Retirement Services, Wilmington, Del.; and Lincoln Trust, Denver.

Now you’re ready to make any of a number of different real estate investments, all of which will enjoy the tax advantages offered by your retirement account. You can direct the trustee to use the funds to acquire a property directly or you can pool your retirement assets with other people’s money to make a larger investment. Other permissible investments include interests in limited liability companies or land trusts that purchase investment properties. In addition, your self-directed IRA or qualified plan can be the source of capital for loans, except to your parents, children, or their spouses. You even can invest in leveraged property through your retirement account. Consider the following example:

Your IRA acquires a property for $100,000, with $20,000 in cash and an $80,000 loan. A year later, your IRA sells the property and nets $150,000 from the sale. After paying back the $80,000 loan, the IRA now has $70,000— the original $20,000 plus $50,000 profit. When investing in leveraged property through your retirement account, certain conditions must be met.

First, the loan must be non-recourse, meaning the lender must agree to look solely to the property as security for the loan and not the retirement account. Some community banks and savings associations will make this type of loan on investment properties.

Second, the retirement account might have to pay an unrelated business income tax (UBIT) or unrelated debt financing income tax (UDFI) of between 15 percent and 35 percent on the income from the financed portion of the property. The taxable income, however, can be reduced through deductions, such as expenses (paid by the retirement account) and depreciation.

Even with the tax payment, investing in leveraged properties can still be a real advantage to your retirement account. In the above example, the IRA would owe a tax of about $12,796, leaving an after tax profit of $37,204 or an after-tax return 186 percent on the cash invested.

When using self-directed retirement assets to invest in real estate, you should consult a professional familiar with these transactions as there are several restrictions
and other factors to be aware of:

• All income from the investment goes into your retirement account and all expenses are paid from the account.
• The real estate purchase must be for investment purposes only.
• You may not purchase property with your self directed retirement account that you already personally own, and you must ensure that your intended purchase isn’t a prohibited transaction.
  

For example, the property to be acquired can’t be owned by your parents, children, their spouses, or a corporation in which you own 50 percent or more.

• Neither you nor your family members (other than siblings) may live in or lease the property while it's in your account.
• Your business may not lease or be located in or on any part of the property while it's in your account.
• You may receive any property as a distribution from your plan as a retirement benefit. So, if you’re 591/2 disquali years old, and you’d rather have the property than cash, you don’t have to liquidate the asset. You will, however, have to pay any applicable taxes, just as you would with a cash distribution.
  

All retirement arrangements give you the opportunity to fund your future with profits from investments in a tax-free or tax-deferred environment. But a self-directed retirement account lets you leverage your real estate knowledge to benefit from a variety of alternative investment opportunities.

Hugh Bromma is CEO of The Entrust Group.

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