Real estate is the most popular alternative asset investment for Self-Directed IRA investors. Real estate is a hard asset that is viewed by many investors as a good hedge against inflation. In addition, many retirement investors appreciate the benefit of diversifying their retirement assets from solely equities. The Self-Directed IRA provides retirement account owners the ability to buy and sell real estate without tax as well as generate tax-deferred rental income, tax-free in the case of a Self-Directed Roth IRA.
- Titling a real estate investment held in a Self-Directed IRA depends on which account you use
- If you utilize the checkbook control structure, the title would be in the name of the LLC
- When using a custodian controlled IRA, the title would be in the same of the custodian, for the benefit of you, the investor
In general, there are two types of self-directed IRAs that allow one to purchase real estate: (i) the Self-Directed IRA, and (ii) Self-Directed IRA LLC.
What is a Self-Directed IRA?
A Self-Directed IRA is not a specifically designated legal or IRS term you will find in the Internal Revenue Code. In essence, a Self-Directed IRA is an IRA account in which the IRA provider allows the IRS to be invested in alternative assets, such as real estate. A Self-Directed IRA follows the same tax rules as a traditional IRA and a Self-Directed Roth IRA follows the same rules as the Roth IRA. The sole distinction is that a Self-Directed IRA can invest in more than just equities, which are solely offered by traditional financial institutions and banks.
The Self-Directed IRA for Real Estate
A Self-Directed IRA, also known as a custodian-controlled Self-Directed IRA, offers an IRA investor more investment options than a financial institution Self-Directed IRA. The custodian controlled Self-Directed is the most common type of Self-Directed IRA.
With it, a special IRA custodian, such as IRA Financial Trust, will serve as the custodian of the IRA. Unlike a typical financial institution, a Self-Directed IRA custodian generates fees simply by opening and maintaining IRA accounts and do not offer any financial investment products or platforms. With a custodian controlled Self-Directed IRA, the IRA funds are held with the IRA custodian and at the IRA owner’s sole direction, the custodian will then invest the IRA funds into traditional or alternative asset classes.
In the case of a real estate investment, the Self-Directed IRA custodian will request the IRA owner to provide all the necessary real estate purchase and closing documents necessary for the IRA custodian to sign. The owner of the real estate asset will be the IRA custodian for the benefit of (FBO) the IRA owner. For example, if Lisa Smith is seeking to buy a property with her Roth IRA located at 1234 Apple Street, City X, State Y, 12345, Lisa will provide IRA financial Trust, as the IRA custodian, the requisite real estate closing documents for signature and title will be in the name of the IRA FBO Lisa’s IRA. Hence, title to property 1234 Apple Street, City X, State Y, 12345 will be as follows:
IRA Financial Trust Company FBO of Lisa Smith Roth IRA.
To establish a Self-Directed IRA for real estate, Lisa would go on the IRA Financial app to open her Roth IRA account. IRA Financial would handle the transfer of her Roth IRA funds from her local bank tax-free. Once the funds were received, IRA financial would notify Lisa who would then notify IRA financial where to send the funds by completing an Investment Authorization form. Lisa would also be able to upload all necessary real estate closing docs on the IRA financial app for IRA financial to sign.
All income and gains from the real estate asset will generally go back to Lisa’s Roth IRA tax-free. All expenses, such as taxes, etc. must be paid by the IRA custodian for the benefit of the IRA since the IRA owns the asset and not Lisa.
The Self-Directed IRA custodian-controlled option is most popular for IRA investors making investments that will not involve a high number of transactions, such as passive fund investments or raw land.
The Self-Directed IRA LLC for Real Estate
The Self-Directed IRA LLC, also known as the Self-Directed IRA with checkbook control, has rapidly become the most popular vehicle for retirement account investors seeking to buy real estate in an IRA. Under the checkbook IRA format, a limited liability company (“LLC”) is created which is funded and owned by the IRA and managed by the IRA holder.
The three primary reasons the Self-Directed IRA LLC has become the most popular self-directed IRA option for real estate investors is as follows:
Limited Liability Protection
Limited liability protection is one the most popular reasons why an IRA investor would elect use an LLC to make an investment is limited liability protection. LLCs, like corporations, are recognized as separate legal entities, meaning individual members of an LLC are protected from debts, obligations, and liabilities of the company. In other words, the power of limited liability protection will protect all of the IRA owner’s assets outside of the LLC from creditor attack. For real estate investors this is very important, especially if the real estate IRA investor will own multiple properties.
Speed & Control
Using an LLC wholly owned by a self-directed IRA will allow the IRA owner to server as manager of the LLC. As manager of the LLC, the IRA owner will have the power and authority to make LLC investment decisions on their own. Whereas, in the case of a self-directed IRA non-checkbook, the Self-Directed IRA custodian must facilitate all future investments or make any payments, such as taxes, additional capital contributions, or payment of real estate expenses. For this reason, the Checkbook IRA is so popular with real estate investors looking to have the opportunity to make investments quickly and without and custodian delay.
An LLC is treated as an entity separate from its owner, even in the case of a Self-Directed IRA LLC. Therefore, the LLC is respected as a separate entity from its owner. Thus, when an LLC makes an investment, the investment is made in the name of the LLC and not the owner. Accordingly, depending on the state in which the LLC was established, identifying the owner of the LLC could prove difficult. Most state will allow you to identify the manager and registered agent of the LLC, although, certain states, such as Delaware and Wyoming make it quite difficult to pinpoint the LLC owner or even manager. Hence, using a self-directed IRA LLC versus the self-directed IRA does provide a higher degree of privacy for retirement investors.
Real Estate Titles
When it comes to how to title real estate owned by a Self-Directed IRA LLC, the title will be in the name of the LLC and not the IRA.
For example, Lisa Smith wishes to purchase 1234 Apple Street, City X, State Y, 12345, using a Self-Directed IRA LLC. Lisa worked with IRA Financial to establish her IRA LLC solution. She elected to form her LLC in the state where the property was to be located and decided to name the LLC – 1234 Apple Street LLC.
After setting up an account with IRA Financial, she transferred $100,000 from an IRA she held at a local bank to IRA Financial. IRA Financial then transferred the $100,000 to a bank account set up for her new LLC.
Once the funds were transferred to the 1234 Apple Street LLC, as manger of the LLC, Lisa can simply wire the funds to the closing agent and take title to the property as follows:
1234 Apple Street LLC
Since the LLC was owned by one IRA, Lisa’s LLC would be treated as a disregarded entity for income tax purposes. Hence, no federal income tax return would be required to be filed. Plus, Lisa, as manager of the LLC, would have the ability to make LLC investments or pay LLC expenses anytime without delay.
The determination of how real estate is titled in a Self-Directed IRA depends on whether the plan elects to use an LLC or not. If an LLC is used, title to the real estate would be in the name of the LLC. However, if no LLC is used, title to the real estate would be in the name of the Self-Directed IRA custodian for the benefit of the IRA owner.
Either way, investing in real estate with a Self-Directed IRA may be the best way to invest. As always, you should consult with a financial advisor before making any investment decisions. Real estate may or may not be the best investment choice for you. If you want more information, please fill out the contact form below.