Self Directed IRAs
Investing IRA funds in real estate used to be quite complicated, time-consuming, and expensive. Deals had to be administered by IRA custodians every step of the way, complicating the process, and fees had to be paid to the custodian every time the IRA made a move. Although much of this is still true with many traditional IRAs, investors can avoid a lot of unnecessary and costly steps by using a self-directed IRA.
A self-directed IRA is simply an IRA in which the IRA owner can make investment decisions without having to get the custodian’s approval. The favorite instrument for opening a self-directed IRA is the Limited Liability Company, which allows the IRA owner to have absolute checkbook control over his or her IRA. This means every time you have to pay an expense associated with an IRA asset, you can write the check yourself and avoid custodian fees.
Making Money with Real Estate
Self-Directed IRAs are great for avoiding taxes on gains, especially for flipping properties. You should use the SDIRA for real estate transactions that generate immediate (or almost immediate) taxable income (such as flips or options) and generally not buy and hold deals, that already shelter other income via componentizing.
There are three basic ways to purchase real estate with a self-directed IRA:
• Purchase with cash
• Partner with family, friend, or business associate
• Borrow money for investment
1) Purchase with Cash
If you have sufficient funds in your self-directed IRA to cover the purchase price, closing costs, taxes, insurance, etc., you can purchase a property outright. All ongoing expenses are paid in total from your self-directed IRA, and all income/profits are returned in total to the IRA.
2) Partner with Family, Friends, and Business Associate
If you don’t have enough funds for a cash purchase, your self-directed IRA can purchase an undivided interest in a property.
For example, with your self-directed IRA, you could partner with a family member, friend, or business associate to purchase a property for $100,000. The friend could provide 70% of the purchase price ($70,000), and your self-directed IRA could purchase the remaining 30% ($30,000).
All ongoing expenses must be paid in relation to your percentage ownership. In our example, for a $1,000 property tax bill, the friend would pay $700 (70% of the bill and your self-directed IRA would pay $300 (30%. If the property collected monthly rent of $1,000, the friend would receive $700 (70% and your self-directed IRA would receive $300 (30%.
3) Borrow Money for Investment:
Through your SDIRA, you could get financing such as a mortgage for a real estate deal. You must consider two points when considering this option:
a) Loan must be non-recourse – Per IRS regulations, an IRA cannot guarantee a loan or be used as collateral. A non-recourse loan only uses the property for collateral. In the event of default, the lender can collect only the property and cannot go after the IRA itself.
b) Tax is due on profits from leveraged real estate – If your IRA uses debt financing such as a loan on a real estate investment, a tax will probably be due on profits. This tax is called unrelated business income tax (UBIT).
Seven Things Every Real Estate Investor MUST Know about Investing in Real Estate with a Self-Directed IRA
1) Your IRA Cannot Purchase Property Owned by You or a Disqualified Person: “Can my IRA purchase a property that I own?” The answer is always no.
IRS regulations don’t allow transactions that are considered “self-dealing,” and they don’t allow your self-directed IRA to buy property from or sell the property to any disqualified person, including yourself.
2) You Cannot Have “Indirect Benefits” from Property Owned by Your Self-Directed IRA: Can your self-directed IRA purchase a vacation home for occasional use? Can you rent office space for yourself in a building that your self-directed IRA owns?
No. The purpose of the IRA is to provide for your retirement at some future date. It’s not intended to benefit you (or any other disqualified person) today. If your IRA engages in a transaction that, in some way, benefits you or a disqualified person, this is considered an “indirect benefit.”
3) Real Estate IRA Investments Are Uniquely Titled: You and your IRA are two separate entities. The investment needs to be titled in the name of your IRA—not in your name.
4) Real Estate in an IRA Can be Purchased without 100% Funding from Your IRA: You can purchase property in more ways than just an outright purchase of the full amount from your account. These other options include using undivided interest and partnering with others.
5) IRA Investments that Use Financing Must Pay UBIT: Your self-directed IRA can purchase real estate using financing as long as the loan is non-recourse. If you do use financing, unrelated business income tax (UBIT) is due.
6) Real Estate IRA Expenses Must Be Paid from Your IRA: All expenses related to property owned by your self-directed IRA (maintenance, improvements, property taxes, condo association fees, general bills, etc.) must be paid from your IRA.
7) Real Estate IRA Income Must Return to Your IRA: All income generated by property owned by your self-directed IRA must be paid into your IRA
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I address many of these issues in my Wealth Building Plan. Make sure you are getting the best tax advice. Let me evaluate your financial and tax situation, then develop a customized tax strategy just for you. Together, we will come up with a strategic plan designed to answer your questions as you build your own customized wealth-building plan. You can get more information at Wealth Building Plan.
