IRA Financial’s Adam Bergman Esq. discusses the best tips if you want to use retirement funds to invest in real estate, whether as an income property or a buy and sell.
Investing in real estate with retirement funds is the number one-way smart investors diversify their holdings. Instead of putting everything into the stock market, which most IRAs are forced to do, you can invest in real estate and other alternative assets when you self-direct. In this podcast, Mr. Bergman outlines the use of a Self-Directed IRA to invest in real estate. Further, he talks about the important IRS rules you should be aware of before you invest.
Top Tips for Real Estate Investing
Let’s get into the tips for using a Self-Directed IRA for investing in real estate.
Do Your Diligence
The first thing you must do is identify property you wish to invest in and then learn everything about it. Do some legwork to learn not only about the property itself, but the neighborhood it’s in, who are you dealing with and what the market is like. This happens even before you get to the IRA investment side of the deal. Understand the deal itself, and how much money you need to make the purchase, taxes that will be due and how much money the property made need for upkeep/renovations.
Obviously, when you are making a real estate investment, it’s generally a lot of money. You must be aware of everything concerning the property. When using a Self-Directed IRA, not only are your current finances put at risk, but also your retirement funds. If anything doesn’t add up, look for a new deal. Therefore, be sure the investment is the right one, before it’s too late.
Prohibited Transaction Rules
Even before doing the legwork on a property, you should be aware of the prohibited transaction rules. Essentially, a disqualified person cannot be involved in the transaction. These include lineal ascendants and descendants, their spouses and entities they control. These are your parents, grandparents, children, grandchildren, etc. If you are looking at a property owned by a disqualified person (or by an entity that he or she owns), stop right there.
The IRA investment must be made to 100% exclusively benefit the IRA. You, as the IRA owner, are a disqualified person, as well. Therefore, you cannot take advantage of the property. This means you cannot purchase a property with your IRA and stay there. You cannot purchase a piece of land owned by your father. You cannot hire your son-in-law to manage your IRA-owned motel. These are all examples of prohibited transactions that could totally disqualify your IRA.
Tax Consequences
A Self-Directed IRA, like any other retirement plan, is tax-advantaged account, meaning you don’t pay taxes on the investment while it’s owned by the IRA. Real Estate is no different. So long as the IRA owns the property, you pay no taxes. All-cash deals are the best way to invest in real estate. If you do not need any financing, you don’t have to worry about taxes. However, if you do need to take a mortgage to purchase the property, you must be aware of the tax consequences.
However, when you do need financing, there are two items to consider. First, the loan must be non-recourse, meaning the lender can only go after the property itself if you default, and not other assets. An IRA cannot guarantee the loan, so you cannot use a recourse loan. Because of this, lenders are a bit harder to find (though, there are those that specialize in this) and interest rates on the loan will be a little higher.
Secondly, you need to familiarize yourself with the Unrelated Business Taxable Income, or UBTI, rules. Your investment is subject to up to a 37% tax on the debt-financed portion of the property. For example, if you purchase a home for $100,000, half in cash and half with a loan. Fifty percent of the income generated from the investment will be subject to UBTI. It’s important that you run the numbers, since UBTI may make an attractive investment less so.
Other Tip to Consider
- When investing with a Self-Directed IRA, it’s best to use only funds in the IRA and not mix with personal funds.
- All expenses, such as taxes and repairs, should be paid out from the IRA. Note: if you have an LLC that makes the investment, the LLC should pay the expenses.
- You can partner with non-disqualified person when making a Self-Directed IRA real estate investment. Expenses and gains should be split based on the percentage each partner invests.
- Make sure to title the property properly.
- Work with a financial advisor and real estate specialists (agent, attorney and the like) when deciding on any investment.
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