Many people believe they need to invest their IRA in bank CDs, the stock market or in mutual funds. However, you can invest real estate with a Self-Directed IRA LLC. This is completely permissible under the Employee Retirement Income Security Act of 1974 (ERISA). The IRS rules allow you to engage in a variety of investments – the opportunities are practically limitless. However, permission is less likely when it involves an investment with a disqualified person.
If you use a Real Estate IRA to invest, you gain more ability to invest in what you know.
Furthermore, the IRS states the following on their website:
IRA law does not prohibit investing in real estate but trustees have no requirement to offer real estate as an option.
The Benefits of a Self-Directed IRA LLC for Purchasing Real Estate
Income or gains generated by an IRA generate tax-deferred/tax-free profits. Using a Self-Directed IRA LLC to purchase real estate allows the IRA to earn tax-free income/gains. Additionally, you can pay taxes at a future date, not in the year the investment produces income. In the case of a Roth IRA the income/gains are always tax-free.
When you have a Self-Directed IRA LLC, you can invest tax-free and not have to pay taxes right away. Or, in the case of a Roth IRA – ever! All the income or gains from your real estate deals flow through your IRA tax-free!
Why Buy Real Estate Using a Self-Directed IRA LLC?
There are so many benefits. Here, we’ll list a few.
- Gains are tax free
- Positive cash flow is tax free
- No time limit for holding property
- IRA can borrow money – leverage your investment with non-recourse financing
- Potential to earn a larger rate of return on invested capital
Tax Advantages of Buying Real estate with a Self-Directed IRA LLC
When using a Real Estate IRA to purchase real estate, typically, all income and gains generated by your pre-tax retirement account investment flows back into the retirement account tax-free. Instead of paying tax on the returns of a real estate investment, you pay tax at a later date. This leaves the real estate investment to grow without interruption.
Generally, self-directed IRA real estate investments are made when a person earns a higher income and is taxed at a higher tax rate. An investment account makes withdrawals when a person is earning little or no income and is taxed at a lower rate.
For example, Joe establishes a Self-Directed IRA LLC with $100,000 to purchase real estate and make other investments. Assume Joe keeps his Self-Directed IRA LLC open for 20 years. Further assume that Joe is able to generate an average annual pre-tax rate of return of 8% and the average tax rate is 25%. By using a tax-deferred Self-Directed IRA LLC strategy, after 20 years Joe’s $100,000 investment will be worth $466,098. That’s a whopping $349,572 after taxes on the earnings. Whereas, if Joe makes the investments with taxable funds (non-retirement funds) Joe only accumulates $320,714 after 20 years.
Real Estate Investments
Below is a partial list of domestic or foreign real estate investments that you can make with a Self-Directed IRA LLC:
- Raw land
- Residential homes
- Commercial property
- Mobile homes
- Real estate notes
- Real estate purchase options
- Tax liens certificates
- Tax deeds
Invest in Real Estate with a Self-Directed IRA LLC Today!
When you purchase real estate with a Self-Directed IRA LLC, it’s very similar to when you purchase real estate personally.
- Set-up a Self-Directed IRA LLC with the IRA Financial Group.
- Identify the investment property.
- Purchase the investment property with the Self-Directed IRA LLC. No need to seek the consent of the custodian with a Self-Directed IRA LLC with “Checkbook Control”.
- Title to the investment property and all transaction documents must be in the name of the Self-Directed IRA LLC. The LLC manager must sign the documents pertaining to the property investment.
- All expenses paid from the investment property go through the Self-Directed IRA LLC. Likewise, all rental income checks go directly into the Self-Directed IRA LLC bank account. No IRA investment checks will deposit into your personal accounts.
- All income or gains from the investment flow through to the IRA tax-free!
How to Structure the Purchase of Real Estate with a Self-Directed IRA LLC
There are many ways that you can structure the purchase of real estate when using a Self-Directed IRA LLC.
1. Use your Self-Directed IRA LLC funds to make 100% of the investment
If you have enough funds in your Self-Directed IRA LLC to cover the entire real estate purchase, including closing costs, taxes, fees, insurance, you can make the purchase outright. Simply use your Self-Directed IRA LLC. All ongoing expenses relating to the real estate investment must be paid out of your Self-Directed IRA LLC bank account. In addition, all income or gains relating to your real estate investment will return to your Self-Directed IRA LLC bank account.
2. Partner with Family, Friends, Colleagues
If you don’t have sufficient funds in your Self-Directed IRA LLC to make a real estate purchase outright, your Self-Directed IRA LLC can purchase an interest in the property along with a family member. The member must be a non-disqualified person. You can purchase with any family member other than a parent, child, spouse, daughter-in-law or son-in–law. You can, however, purchase with a friend, or colleague. The investment does not go into an entity by the IRA owner. Instead, it goes directly into the property.
For example, your Self-Directed IRA LLC could partner with a family member. Again, a non disqualified person who isn’t a parent, child, spouse, daughter-in-law, son-in–law. However, you can make the purchase with a friend, or colleague for a piece of property at $150,000.
Your Self-Directed IRA LLC can purchase an interest in the property (i.e. 50% for $75,000) and your family member, friend, or colleague can purchase the remaining interest (i.e. 50% for $75,000).
All income or gain from the property is allocated to the parties in relation to their percentage of ownership in the property. Likewise, all property expenses must be paid in relation to the parties’ percentage of ownership in the property. Based on the above example, for a $2,000 property tax bill, the Self-Directed IRA LLC is responsible for 50% of the bill ($1000). The family member, friend, or colleague is responsible for the remaining $1000 (50%).
Isn’t Partnering with a family member in a Real Estate Transaction a Prohibited Transaction?
Likely not, as long as you structure the transaction correctly. Investing in an investment entity with a family member and investing in an investment property directly are two different transaction structures that impact whether the transaction will be prohibited under Code Section 4975. The different tax treatment is based on who currently owns the investment. However, if you use a Self-Directed IRA LLC to invest in an entity a disqualified family member owns will likely be treated as a prohibited transaction.
However, partnering with a family member that is a non-disqualified person into an investment property is likely not prohibited.
Note: If you, a family member, or other disqualified person already owns a property, then investing in that property with your Self-Directed IRA LLC is prohibited.
3. Borrow Money for your Self-Directed IRA LLC
You may obtain financing through a loan or mortgage to finance a real estate purchase using a Self-Directed IRA LLC. However, consider two important points when selecting this option:
Loan must be non-recourse
A “prohibited transaction” is a transaction that, directly or indirectly involves the loan of money or other extension of credit between a plan and a disqualified person. Normally, when an individual purchases real estate with a mortgage, the traditional loan provides for recourse against the borrower (i.e., personal liability for the mortgage). However, if the IRA purchases real estate and secures a mortgage for the purchase, the loan must be non-recourse. Otherwise there will be a prohibited transaction. 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
Tax is due on profits from leveraged real estate
Pursuant to Code Section 514, if your Self-Directed IRA LLC uses non-recourse debt financing (i.e., a loan) on a real estate investment, some portion of each item of gross income from the property are subject to Unrelated Business Income Tax (UBTI). “Debt-financed property” refers to borrowing money to purchase the real estate. For example, a leveraged asset that is held to produce income. In such cases, only the income attributable to the financed portion of the property is taxed. Gain on the profit from the sale of the leveraged assets is also UDFI. Of course, unless the debt is paid off more than 12 months before the property is sold. There are some important exceptions from UBTI. Those exclusions relate to the central importance of investment in real estate, such as:
- Most rentals from real estate
- Gains/losses from the sale of real estate
However, rental income generated from real estate that is “debt financed” loses the exclusion. That portion of the income becomes subject to UBTI. Therefore, if the IRA borrows money to finance the purchase of real estate, the portion of the rental income attributable to that debt will be taxable as UBTI.
For example, if the average acquisition indebtedness is $50 and the average adjusted basis is $100, 50 percent of each item of gross income from the property is included in UBTI.
A Self-Directed IRA LLC subject to UBTI is taxed at the trust tax rate because an IRA is considered a trust. For 2018, a Self-Directed IRA LLC subject to UBTI is taxed at the following rates.
- $0 – $2,550 = 10% of taxable income
- $2,551 – $9,150 = $255 + 24% of the amount over $2,550
- $9,151 – $12,500 = $1,839 + 35% of the amount over $9,150
- $12,501 + = $3,011.50 + 37% of the amount over $12,500
Did you know?
You should form your Self-Directed IRA LLC in the state where the real estate will be located.