Seven Things You Must Know about Investing in Real Estate with an IRA
Historically, real estate has given many Americans a stable investment vehicle that provides both income and appreciation. One of the greatest tools available to real estate investors is government-sponsored retirement plans, such as IRAs and 401(k)s, which can provide generous tax-advantages to their investment.
IRS Regulations Allow Clients to Invest Retirement Funds in Real Estate
Few clients realize that they have the option to self-direct their IRAs and other retirement plans into real estate and other alternative assets falling within IRS regulations. This creates a great opportunity for tax professionals, financial advisors, attorneys and the client. Advisors can bring a new investment strategy to their clients and clients benefit from portfolio diversification and the tax-advantages provided by the plan’s tax-deferred or tax-free status.
Additional advantages include:
- The power of compound interest
- A reduction of taxable income
- Asset protection
- Estate planning
The list of real estate related investments that one can make varies by custodian but generally includes:
- Raw land
- Residential property
- Commercial property
- Tax liens certificates
- Mobile homes
- Real estate notes
- Second mortgages
- Real estate purchase options
Important: Not all custodians are set-up to provide custody for these investments. Make sure to research and seek out custodians that accept real estate investments. Also, while the list covers a broad range of opportunities for clients, there are several important points and IRS regulations to note before making the investment.
7 Things to Know When Planning to Self-Direct IRA in Real Estate
- Client’s Retirement Account Cannot Purchase Property Owned by the Client or a Disqualified Person
One of the most common questions about investing retirement plans in real estate is: “Can my IRA purchase a property that I currently own?” The answer is always no.
IRS regulations do not allow transactions that are considered "self-dealing," and prohibit a self-directed account to buy property from or sell property to any disqualified person, including yourself (See IRS publication 590).
- Clients Cannot Have “Indirect Benefits” from Property Owned by Their Self-Directed Accounts
Can the client’s self directed account purchase a vacation home for the client to occasionally use? Can the client rent office space for himself in a building that his self-directed account owns?
The purpose of the retirement account is to provide for your client’s retirement at some future date. It's not intended to benefit the client (or any other disqualified person) today.
- Real Estate Retirement Account Investments Are Uniquely Titled
The client and her IRA are two separate entities. As such the investment needs to be titled in the name of her IRA —not in the client’s personal name. All documents related to the investment must be titled correctly to avoid delays in completing the transaction for the client.
The correct title for most real estate IRA investments is:
"Name of Custodian FBO (for benefit of) [Your Name] IRA"
- Real Estate Can be Purchased without 100% Funding from Your Client’s Retirement Account:
Clients can purchase property in more ways than just an outright purchase of the full amount from their accounts. These other options include using undivided interest and partnering with others.
- Retirement Account Investments that Use Financing Must Pay UBIT
Self-directed IRAs can purchase real estate using financing as long as the loan is non- recourse. An investment that generates income with debt financing (such as purchasing real estate with a non-recourse loan in an IRA) is responsible for UBIT in direct proportion to the gain/income that's debt financed.
- Real Estate Expenses Must Be Paid from the Retirement Account
All expenses related to the property owned by the self-directed account (maintenance, property taxes, association fees, general bills, etc.) must be paid from the account proportionate to the IRA’s investment in that property. For example, if your client purchased a 50% interest in the investment, then 50% of the expenses must come from the IRA.
IMPORTANT: Clients are not permitted to pay expenses from personal accounts. Expenses must be paid from the self directed account. Co-mingling of funds could be considered a prohibited transaction.
- Real Estate Income Must Return to the Account
All income generated by property owned by your client’s self-directed account must be paid into the account. Renters/Payers must make out checks to your self-directed IRA, not to you personally.
If you have clients who are already successful real estate investors, or if you're just looking to diversify their retirement portfolio, the combination of real estate and their retirement account can be very powerful.
For more information about real estate in IRAs, download our free report: “A Guide to Real Estate Investing with a Self-Directed IRA: Everything You Need to Know from A to Z”