With an IRA, you’re limited to only contributing so much out of pocket each year. In tax year 2022 you can contribute up to $6,000 to a traditional or Roth IRA when you’re under age 50; up to $7,000 when you’re 50 and older.
Despite these relatively low dollar amounts, there are strategies for real estate investors looking for ways to grow their IRA in a short period of time. Provided you follow the rules, property wholesaling and real estate options provide two such opportunities to grow a small retirement account significantly.
Real estate wholesaling in an IRA
Wholesaling is essentially an A to B to C transaction. For example, there is a seller – someone who owns a property. Maybe it’s a vacant house, estate sale, or probate. The seller is in some sort of position to sell the property at a discount. You as the investor have the opportunity because you found this deal to negotiate a discounted price and sell it to an end buyer who buys and rehabs properties.
Maybe the buyer doesn’t want to go out and hunt for transactions. They prefer to find someone like you, a wholesaler that has good deals, and they can acquire those properties from you in cash.
In addition to the seller, there is your IRA: it could be your Roth IRA or traditional IRA. A lot of investors like to use their Roth IRA for these types of transactions because of the tax-free upside. With a Roth IRA, when you put money in it’s after-tax, so it grows tax-free. As long as you follow the rules, when you take a withdrawal after 59½, you pay 0-percent tax. You could also use a Coverdell Education Savings Account (CESA) or a Health Savings Account (HSA) and receive these tax advantages.
The property goes under contract in the name of the IRA or other account. For example, instead of the contract buyer listed as John Bowens, it will be listed as “Equity Trust Company custodian FBO (for benefit of) John Bowens IRA.” Because I have my account with Equity Trust Company, I log into my Equity Trust account online. I key in all the information and request that Equity Trust Company writes the check or sends the wire transfer out to open escrow for my earnest money deposit.
My earnest money deposit must be paid for from my self-directed IRA. I couldn’t write a personal earnest money deposit for a property and then have my IRA benefit.
Video: Investing in Wholesale Properties and Real Estate Options with a Self-Directed IRA
Wholesaling real estate example: $500 into $10,000
Let’s say I put a property under contract for $50,000. I then sell that contract to a rehabber for $60,000. I write an earnest money deposit to the seller, person “A” for $500. My total investment from my self-directed IRA is $500.
Some active wholesaling investors might wonder, “why $500 down? Sometimes I only put a dollar down or $10.” A self-directed IRA is a tax-privileged account and there’s no clearly defined guideline in terms of $10 is not enough, but $500 is OK. It’s a rule of thumb that’s used in the industry. Check with your tax attorney or CPA to determine what they feel is in your best interest. But I know that a lot of investors prefer to put maybe a few hundred dollars down on a deal so that they have some “skin in the game.”
In this example, I have $500 down, and a contract for $50,000 assigned to an investor buyer. The contract is assigned from B to C, from my IRA, HSA, or CESA, to the end buyer. My self-directed IRA may not have 50,000, but the account had enough for the earnest money deposit, secured the contract, and then assigned the contract to the end buyer.
In this case, I have a $10,000 assignment fee, which goes back into the self-directed Roth IRA. And because it’s in my self-directed Roth IRA, there’s no short-term capital gains tax.
Tax-free real estate profits for an HSA: Mark from North Carolina
Here’s another example of wholesaling, with a different type of account: Mark from North Carolina established an HSA and deposited $500. To find properties, he performs a direct mail campaign, mailing letters to absentee property owners. When they reach out to him, he negotiates to buy their properties.
He found a property in North Carolina and put it under contract for $10,000. His HSA made a $100 earnest money deposit. Then he assigned that contract to an investor buyer for 15,000. He made the spread of 5,000. After his $100 earnest money deposit was accounted for, he made a $4,900 tax-free profit for his HSA.
Should he choose to withdraw that money, as long as he uses it for healthcare-related expenses, it’s tax-free. You could plug-and-play a Roth IRA, Traditional IRA, Solo 401(k)…you name the tax-advantaged investment account, you can deploy this type of strategy.
Real estate option example
A real estate option is very similar to a wholesale transaction. The difference is that a real estate option gives the optionee the right to buy a property at a future date at a predetermined price, similar to a stock option.
Here’s an example: This past year, an Equity Trust client named Chris put a commercial property (storage facility) under contract in her Roth IRA with an option. It was an A to B to C transaction, just as before. The seller, who is player A here, owned a commercial building and Chris’s Roth IRA (Chris on behalf of her Roth IRA), put the property under contract in a distressed situation.
Chris has investors in her network who are looking for commercial real estate deals. She brought player A and player C together leveraging a real estate option. Her Roth IRA wrote a check to the seller for $2,000 to put the property under contract with an option. She had the right to assign the option contract to anyone.
She assigned the option contract to the end investor buyer, who bought the contract for a $20,000 assignment fee. She invested $2,000 and made a $20,000 profit, tax-free because it was in her Roth IRA.
The real estate option vehicle parallels the wholesale transaction vehicle; however, from a legal documentation perspective, they are two different transactions. In terms of preparing your real estate option contract versus a traditional purchase agreement, speak with your real estate attorney.
One more thing to consider about real estate options and wholesaling
When using your self-directed IRA or other account for wholesaling or options, be cognizant of your account being viewed as running itself, like a business, and potentially being subject to unrelated business income tax (UBIT). If you perform too many of these types of transactions in one year, there is the possibility of triggering UBIT.
In addition, when conducting these types of transactions, it’s important that there’s some “skin in the game,” or a significant capital investment, proportionate to the gains on the particular property acquisition.
John Bowens is one of the most sought-after and respected educators in the self-directed IRA industry, partly due to his unique ability to take a complex issue and break it down into simple-to-understand terms. Currently a Senior Manager at Equity Trust Company, John draws from his 15 years in the real estate industry and his experience as an active real estate investor. In his travels across the U.S. and virtually, he has trained 60,000 investors during more than 300 workshops and classes, spreading the message about the power of building tax-free wealth and leaving a lasting legacy by investing in what you know best.
John contributed to the book “Self-Directed IRAs: Building Retirement Wealth Through Alternative Investing” with Equity Trust Company Founder Richard Desich, Sr., and has appeared on several national real estate and finance-related radio shows, including the Rich Dad Radio Show.
1
Can my IRA purchase real estate that I currently own?
No. This is considered a prohibited transaction (see IRC 4975). You may not purchase a property, or interest in a property, that’s currently owned by a disqualified person, which includes yourself.
2
Can my IRA purchase real estate that my corporation, partnership or LLC owns?
No. This is considered a prohibited transaction (see IRC 4975).
Case studies provided are for illustrative and educational purposes only. Past performance is not indicative of future results. Investing involves risk, including the possible loss of principal. Quotes and information included in the case studies and testimonials were provided by the investors and included with permission. Equity Trust Company does not independently verify all information provided by third parties.
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