I get many questions about how to invest in real estate with an IRA or retirement money. I have never used any retirement accounts to invest in real estate, and I don’t think I am the right person to write about the subject. Matthew Tillack is a real estate investor and manager with the iPlan Group, which specializes in self-directed investing. Matthew was kind enough to write this post that explains more about self-directed IRAs and how you can use them to invest in real estate.
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What is a Self-Directed IRA?
A self-directed IRA is an IRA (Roth, Traditional, SEP, SIMPLE, Inherited IRA) where an investor can invest into a range of investment options as long as the custodian of the account allows the IRA to invest in to any of the alternative investments allowed by law. These investments may include; real estate, tax-liens, promissory notes, private company stock, precious metals, and other alternative assets.
The typical reaction I hear from new prospects when discussing these plans is: “Why haven’t I ever heard of self-directed IRAs before?” The main reason is that most large financial institutions that administer U.S. retirement accounts prefer to stick to their core business (publicly traded assets) and they find alternative assets, such as real estate and non-publicly traded investments, to be paperwork intensive and more work to process, so they consider these to be “not administratively feasible” to hold. Because of this, they do not allow investors to purchase or invest in these asset classes inside of retirement plans. A truly self-directed administrator specializes in these transactions and can hold wide a range of investments.
What Can a Self-Directed IRA Invest Into?
The good news is that under current law, a retirement account is only restricted from investing in the following:
– Collectibles (for example, artwork, antiques, jewelry, alcoholic beverages, or coins other than U.S. gold coins)
– Life insurance
– S-corporation stock
– And, any investment that constitutes a prohibited transaction under ERISA law and/or IRC 4975
That leaves a lot of other alternative investment options! Here are some of the many options you can take advantage of:
- Commercial property
- Residential property
- Undeveloped land
- Developed land
- Leases and lease options
- Trust deeds and mortgage notes
- Mobile homes
- Rehabs and flips
- Storage units
- Farm land
- Foreign Real Estate
- Joint ventures and partnering
Tax Liens/Tax Deeds
- Tax lien
- Tax deed
- Secured notes
- Unsecured notes
- Mortgage/deeds of trust
- Automobile paper
- Commercial paper
- Private stock offerings
- Limited liability companies
- Limited partnerships
- C corps
- Joint ventures
- Hedge funds
- Foreign entities
- Startup companies
Traditional Assets (publicly traded securities)
- Mutual funds
- Structured settlements
- Accounts receivable
- U.S. Treasury gold and silver coins
- Gold bullion, silver bullion, platinum and palladium
- Foreign currency exchange
- Oil & gas ventures
- Mineral rights
- Water rights
- Equipment leasing
- Certain intellectual property
The list goes on…
How can an investor get started with a self-directed IRA?
Now, today’s investors can take charge and have more control over their retirement destiny. A self-directed IRA can be an important piece of a well-rounded retirement portfolio. While owning real estate and other alternative assets inside of a retirement account is an exciting prospect, investors must be mindful of the many rules and procedures involved in managing this type of account. Finding a regulated self-directed IRA custodian that will hold the title to alternative assets for the benefit of an IRA and learning the rules and regulations regarding self-directed IRAs are important steps in the process of successful self-directed IRA investing.
When self-directing your retirement account, it’s very important to be aware of the prohibited transaction rules found in IRC 4975. The prohibited transaction rules restrict your retirement account from engaging in a transaction with someone who is considered a disqualified person to your account. The easiest way to remember disqualified people is to look at it this way: disqualified people are you, your spouse, and anyone above or below you on the family tree, such as parents/grandparents, children/grandchildren and certain business partners. So, for example, your retirement account cannot purchase a property that is owned by your mother since a purchase of the property would be a transaction with someone who is disqualified to the retirement account. However, your retirement account can buy a property from your brother, cousin, friend, or a random third-party, as these parties are not disqualified persons under the rules.
Essentially the rationale behind the prohibited transaction rules is that the federal government doesn’t want tax advantaged accounts conducting transactions that benefit parties other than the IRA. The sole purpose of an investment should always be to benefit the IRA holder’s account and not the IRA holder (at least not until retirement) or anyone else who is considered disqualified. The consequence of a prohibited transaction is disqualification of the retirement account as of January 1 of the year the prohibited transaction occurred with potentially hefty penalties and taxes.
How can an investor purchase real estate with a self-directed IRA?
When conducting a typical self-directed IRA real estate investment, your IRA custodian holds your investment in their company name for the benefit of the IRA. The title to the property (e.g. iPlan Group Agent for Custodian FBO John Smith IRA) is listed on all documentation pertaining to that investment and the company receives the income and pays the expenses for the investment per the instruction of the IRA account holder. It is very important to understand that it is considered a prohibited transaction to use personal funds for any expenses or to deposit any IRA funds (e.g. rental checks) into a personal account.
When purchasing real estate, you’ll need to request funds for making the investment. This is done by filling out an investment authorization form which is sometimes referred to as a Direction of Investment or Letter of Direction. This authorizes your custodian to send funds out for the investment you’re making using your IRA. Typically one investment authorization form is sent in along with the properly titled purchase contract for the earnest money check and then another is sent to request the remainder of the funds for closing. All documentation other than the purchase contract (e.g. HUD-1, deed, etc.) will be sent to your custodian prior to closing as the custodian will sign the documentation for closing on behalf of the IRA.
From here on out, it’s a simple processes of sending in any income, such as rental checks, to your administrator/custodian with that company’s deposit coupon and then paying any expenses, such as paying a contractor, property manager, or lawn care company using that company’s bill pay request form.
If you want complete control over your investments and the chance to maximize those investments by investing in to what you know, a self-directed IRA may be the right choice for you. A truly self-directed IRA that encompass a wide range (or a narrow range, depending on your own preferences) of investment options puts you in the driver’s seat when investing your retirement funds. Instead of putting the fate of your retirement funds into the hands of your employer and/or financial planner, you’ll be taking a more hands-on approach to investing your hard-earned cash. If you’ve had success investing in assets other than stocks, bonds, and mutual funds, you’ve probably wished that you could include these other investments in your IRA, 401(k) or other retirement plans. And if you are anything like me, you’re most comfortable investing your IRA in what you know and understand, which could be real estate.
By: Matthew Tillack, real estate investor and sales manager of iPlanGroup.
From my personal experience as a real estate agent, I have seen many investors use self-directed IRAs to buy rental properties. It is very important to chose a great company when investing self-directed retirement funds. Since you have to have the IRA custodian sign the contract and all documents; it can take some time to get offers in and documents signed. If that custodian takes too long you may miss out on some great deals.