Guy from Georgia was intrigued by the concept of using his Roth IRA to invest in real estate. One aspect had him hesitant to act, though: while it is possible to self-direct your Roth IRA or other account into a variety of assets including real estate, it is important that IRS rules are followed. For example, you may not perform work on a house you purchase with your self-directed account. In addition, any expenses related to the investment must be paid from the account.
Guy didn’t know if he’d be able to spend the time necessary to make sure a self-directed real estate investment was within IRS guidelines. Plus, when he reached out to others in the industry, such as insurance agents, their unfamiliarity with self-directed investing presented another hurdle he would have to clear.
While looking for a more hands-off approach to self-directed investing, Guy began to research hard money lending online. He uncovered the name of a mortgage broker who seemed to be reputable. He contacted the broker to learn more about note investing. After a productive conversation and more due diligence, Guy decided self-directed note investing was his path forward.
Hands-off investing leads to steady profits
Guy decided to work with the broker he spoke to and since then has completed several short-term note investments, each with terms of approximately 12 months. He likes that the broker conducts all the vetting of loan applications, appraisals, and renovation plans, and he weeds out what he considers to be riskier investments.
The broker works with a loan servicing company to handle interface with the borrower and submitting all payments directly to Equity Trust via ACH deposit. Loan servicing costs are covered by the broker out of the 2-percent spread they keep from each loan.
The broker keeps construction reserves in their escrow account. “This allows the broker (and the investor – me) to have a little more oversight on each subsequent draw – he schedules inspections and we both review the report,” Guy explains. “The funds aren’t released until we’re both satisfied.”
For a recent investment, Guy purchased a real estate fix-and-flip note with 12 monthly interest-only payments and a balloon payment at the end. Guy directed Equity Trust to send his broker $109,800 for the purchase of the note.
With Equity Trust’s account management system myEQUITY, this step can be completed online. myEQUITY’s Private Debt Wizard walks the investor through the process of initiating the investment, eliminating the confusion that might arise for those unfamiliar with the self-directed investing process.
Guy received monthly interest payments deposited directly into his Equity Trust Roth IRA via ACH. Those deposits, as well as the 10-percent profit, are not taxed.
Investing inside vs. outside an IRA
Because all income must go back to the IRA, Guy works with Equity Trust to make sure his payments are directed to the proper account.
“I’ve got to send in a deposit coupon to Equity Trust when the direct deposit goes into my account each month, but that’s easy,” he says. “I can email that or mail it in, however I want.”
Even though he’s working with a broker, Guy carries the ultimate responsibility of vetting out prospective investments. There have been a couple investments offered to him that he declined after doing his own property and market research.
Guy has found that the notes don’t always carry to the full 12-month term. One borrower sold the property early, so the note was paid back to Guy early. In another situation, the repayment period went into the 13th
month. These factors can affect the return on investment (ROI), but in general Guy receives a 10-percent ROI on his notes. He almost always has at least one active note in his IRA.
“I don’t know where else I can get 10-percent ROI with the level of risk I’m getting,” Guy says.
Finding funding when the IRA comes up short
One of the first times Guy’s broker approached him with an attractive investment, Guy didn’t have the funding in his Roth IRA for the opportunity. Not wanting to lose the opportunity, he found a solution.
By co-investing his Roth IRA money with money from outside of his retirement account, Guy could put together enough money for the investment. He would invest with the proportions of 28 percent of his IRA money and 72 percent of his personal money.
When co-investing an IRA with another IRA or any other funding source, it’s important that all expenses and revenues remain in the same proportions as the initial investment. Thus, any revenue that would come from Guy’s note investment would be split, and 28 percent of it goes back into his IRA.
Due to the rules involved with co-investing, Guy’s broker resisted proposal at first, fearing the process would become too complicated or an administrative burden.
It was easier than Guy thought to change the broker’s mind.
“I mentioned I was using Equity Trust as my IRA custodian, and he said, ‘Oh, co-investing is not a problem then. We work with them all the time and we’ve never had a problem.’ It was like night and day when I mentioned Equity Trust,” Guy says. “[My broker] has a lot of investors who invest through Equity Trust.”
Considering his family’s future
Guy, who is married with two children, plans to use his self-directed investing to build a legacy. He lives off his pension earned from 24 years serving in the Army. If he does need to draw from his Roth IRA in retirement, withdrawals are tax-free.
Barring any unexpected circumstances, his Roth IRA will be left to future generations, who will be able to take tax-free withdrawals from the account.
Guy plans to continue investing in notes while receiving 10-percent interest as long as he can – he hopes he’ll be able to use this strategy until he’s 70. He knows the real estate market might not continue to provide these opportunities, so he’s researching other hands-off strategies for diversifying his portfolio.
Read about more real-life investments: download your free guide with 11 self-directed investing case studies.
Case studies are provided for illustrative purposes only. Past performance is not indicative of future results. Investing involves risk including possible loss of principal. Information included in the above case study was provided by the investor and included with permission. Equity Trust Company does not independently verify all information provided by third parties.