Over the last decade I have seen self directed IRA investors buy anything from trending securities to private data networks, from small business financing to note buying and everywhere in between. So in this day and age I am always amazed at how many people are still not aware that they can invest their IRA into real estate. Even real estate professionals and savvy investors can be left in the dark when it comes to putting real estate into an IRA. But the fact is that, YES, IRAs can be utilized for a variety of real estate investment strategies. Rental properties, asset backed lending, renovated flips and even real estate options are just a few real estate investments IRA owners are capitalizing on. There are a multitude of benefits to having real estate in an IRA, including compound interest in a tax favorable account and an added layer of security in unstable markets. It’s safe to say that having real estate in your IRA is a great way to strengthen your financial stability to secure your retirement account.
Why Real Estate is a Smart Investment Strategy
Conventional IRA investments like stocks, mutual funds, futures, etc… are intangible, can be nearly impossible to research with diligence and are often so complex that they require financial experts in order to succeed. With so many foreign and unforeseen variables affecting the outcome of your investment one must either have an enormous amount of faith or seek alternative methods to make safe and consistent profits. So putting real estate in an IRA is a great way to diversify, protect and grow wealth for your retirement years. Real estate is not only a tangible asset, but it is an investment that is easy to understand. Real estate can incur safer and greater rewards, especially when you account for long term appreciation on top of cash flow.
As a real estate investor you can find opportunities in every city in the U.S. as well as real estate investments abroad. You can find investment properties and lease them to businesses, single families, multi unit properties, even raw land can be a good investment. In real estate there are many roads an investor can take. Tax deeds, short sales, fixer uppers, estate sales or just plain ugly homes can be found at discount prices and you can turn a profit by simply buying under market value. Trailer parks may not sound exotic but it is a cash cow market where investors capitalize on leasing land, selling trailers, renting them or all of the above. In hot markets, here in Austin Texas for example, you can buy move-in-ready real estate and profit from rapid appreciation while generating a revenue stream from the growing demand for commercial leases as well as personal dwellings. If you don’t want the hassle of toilets, trash and tenants one of the safest and most hassle free investments is real estate backed lending. After all, what do you think the bank does when you buy a certificate of deposit (CD)?
The Power of Putting Real Estate in an IRA
One of the biggest expenses for a real estate investor is income taxes. Investment property can offer tremendous benefits but many real estate investors are paying taxes on cash flow before it is re-invested into more investment property. Over time this significantly reduces the bottom line and will add years or even decades to your wealth building strategy. If you sell investment property outside of an IRA you will need re-invest into like kind property immediately or face hefty tax liabilities before re-investing your profits.
Under a real estate IRA the revenue and profits are generally protected from taxation until you decide to take IRA distributions for personal use. Even then, you are only taxed on the amount distributed from the IRA. In real estate IRAs we can see a snowball effect as investors compound profits before taxation. This allows real estate IRA investors to build wealth much faster than other real estate investors. For example, let’s take $200,000 and give it a 10% compounding ROI every year:
In year one the IRAs value is $220,000, year two it is $242,000, year three it is $266,200 and so on… When we make the same investments outside of an IRA and assess a 20% tax on the profits year one the balance is $216,000, year two it is $233,280, year three it is $251,942 and so on… After 10 years the IRA has over $70,000 more than the taxable account and after 20 years it has roughly $360,000 dollars more.
Important Things to Remember
When putting real estate in an IRA you must keep in mind that your IRA is a separate entity from you personally. The deed to your property can be held in the name of your IRA custodian or you can hold title under an IRA LLC. Holding property in your personal name is strictly prohibited under a real estate IRA. Any maintenance or other expenses related to the real estate IRA should be covered directly by the IRA, not the IRA owner. The same goes for any income, it must be returned back to the real estate IRA, not to your personal account. Any documents pertaining to the real estate in your IRA must be signed by the IRA custodian or third party administrator. In the case of an IRA LLC you can personally sign but must do so in the capacity of a manager for the IRA LLC. Utilizing debt financing is possible with real estate IRAs but you as an IRA owner cannot personally guarantee a loan or extend your personal credit to the IRA, which will eliminate conventional financing.
One way to look at a real estate IRA is as if you are managing an account for someone else i.e. a client, a church, a non-profit organization or a trust where you are named the trustee… This type of thought process will simplify your role as a self-directed IRA investor and keep you out of trouble.
Limitations of Having Real Estate in an IRA
Real estate IRAs are subject to the same rules as any other IRA so self-dealing transactions are typically considered distributions from your IRA. Aside from life insurance and collectibles, there are 6 prohibited transactions. Making a prohibited transaction will basically distribute the entire balance of your IRA and incur hefty taxes and sometimes even penalties. The 6 prohibited transactions are:
1-sale or exchange, or leasing, of any property between a plan and a disqualified person;
2-lending of money or other extension of credit between a plan and a disqualified person;
3-furnishing of goods, services, or facilities between a plan and a disqualified person;
4-transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a plan;
5-act by a disqualified person who is a fiduciary whereby he deals with the income or assets of a plan in his own interests or for his own account; or
6-receipt of any consideration for his own personal account by any disqualified person who is a fiduciary from any party dealing with the plan in connection with a transaction involving the income or assets of the plan.
In other words: As a real estate IRA owner you shouldn’t sell your property to your real estate IRA or buy property from your real estate IRA. You shouldn’t lend money or extend credit to your IRA for real estate investments. You shouldn’t personally work on the property or use your own tools to upgrade the property and you definitely should not live in or personally benefit from real estate owned in your IRA. Disqualified people such as your spouse, vertical bloodline, or spouse of your descendants are also restricted from making one of these self dealing transactions with your real estate IRA.
Sit Back and Watch Your IRA Grow
If done correctly, putting real estate in an IRA will set you on the path to success and you won’t find the need to take high risks just to realize decent returns. With a real estate IRA portfolio you can add an extra layer of security while you sit back and watch the monthly checks come in. And rest assured, with a real estate IRA you won’t get that dreaded call from your financial advisor the next time the stock market takes a dive.
Let’s face it, the days of putting your money in a bank and safely living off the interest is a thing of the past-but when you put real estate in an IRA it can be a reality once again. So don’t let your financial institution hold you back from real estate investing, it’s your money and should be invested assets that you understand. So the next time you talk to your custodian, ask them how to diversify and grow your IRA with real estate.