Ohio resident David had grown frustrated during the past few years after having a couple of potential real estate investments fall through due to a lack of funding.
In the fall of 2016, another opportunity presented itself. David learned of a pre-foreclosure property nearby that was being auctioned off. He knew that being able to make a cash purchase would increase his chances of winning the bid.
This time, David was ready. Through research and discussions with his financial advisor, he learned that he had the funding to purchase the property. He could purchase it in his retirement fund.
Best-kept secret for real estate investors?
Investors can use self-directed IRAs and other retirement accounts to invest in a variety of assets, in addition to stocks and bonds that most investors know. Allowable investments include real estate, tax liens, promissory notes, private entities, and more.
Self-directed accounts include the Individual Retirement Account (IRA), Roth IRA, 401(k), Simplified Employee Plan (SEP), and Savings Incentive Match Plan for Employees (SIMPLE), as well as Health Savings Account (HSA) and Coverdell Education Savings Account (CESA).
In a self-directed investment, money from an IRA or other account is used to invest in an asset, and all profits and expenses flow through the retirement account. Tax advantages include tax-free or tax-deferred growth within the account.
Though David just recently learned about the concept, self-directed investing is nothing new. Since IRAs were introduced in 1974, the IRS has only listed a handful of items that are not
permitted in an IRA (the entire list can be found in IRS Publication 590
Self-directed investing gains favor
Like David, other real estate investors are becoming aware of the possibility of self-directed investing. After years of investing in real estate, Lowell of California learned about the concept in 2013 and decided to transfer his 403(b) account into a self-directed IRA. He then acquired a bank-owned property for just over $85,000.
Lowell rented the property for two years, providing consistent cash flow and growth back to his IRA, until the property sold in December 2015. Between the rental income and the sale price, the property generated nearly a 77-percent return on investment (ROI).
An experienced real estate investor, Lowell prefers the idea of using his IRA over borrowing to fund his investments.
“Since my IRA now owns each property, I know that even if a property sits vacant, I am not losing money other than the necessary costs of insurance and taxes,” he says.
Laurie of Colorado learned about self-directed investing from her father, who is a real estate agent. She opened a self-directed IRA, and partnered with others, funding her LLC to buy a condo. Her husband’s IRA partnered with her LLC to buy another condo. As soon as she has enough saved in her IRA, Laurie plans to invest in a property 100 percent in her IRA.
“I wish I could do more of these self-directed investments,” she says.
Real estate investing indirectly with retirement accounts
For those who prefer not to directly invest in real estate or other assets, a self-directed IRA’s versatility allows for other possibilities. For example, some investors boost their retirement savings by loaning IRA money to other investors.
Susan from New York recently partnered with family members’ IRAs (three total) to loan a real estate investor money to rehab a house. She used a third-party servicer to structure the promissory note. During a 14-month term, the note yielded a return of over $42,000, a 25-percent ROI.
Susan recalls being delighted to learn about the possibility of investing in alternative investments with her retirement account.
“To my surprise, I discovered there were many non-traditional assets such as real estate, tax liens and promissory notes that our retirement dollars could invest in using a self-directed IRA,” she says.
Self-directed investors aren’t limited to only investing with other self-directed investors. Christine from California is one of a group investing in a hotel being rehabbed in Ohio. She is funding her portion of the investment from her IRA. The IRA receives monthly income from room rentals, and Christine expects her IRA to receive a profit of about 25 percent once the hotel is sold.
How to get started with self-directed investing
As with any investment, your due diligence is key. Before making an investment decision consult with a tax, legal or financial professional.
In addition to the list of investments not permitted in an IRA, the IRS provides information in IRS Publication 590
Unqualified Business Income Tax (UBIT)
Only certain custodians offer self-directed accounts because the required reporting and recordkeeping is unique. Equity Trust Company is one such custodian. Through its predecessor company, Equity Trust began offering self-directed accounts in 1983.
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The above case studies are for educational purposes only. Past performance is not indicative of future results. Investing involves risk, including possible loss of principal. Information included in the above case studies were provided by the investor and included with permission. Equity Trust Company does not independently verify all information provided by third parties.