Purchasing a vacation home with your IRA/401k plan

Summer vacations are the perfect time to find a dream home in the perfect location. Today’s investors sometimes need clever solutions for affordability, so it’s important to be aware of all of the available investment tools. One such tool is the self-directed IRA. Did you know that your IRA/401k funds can be used to buy real estate? Let’s look at some of the options available for purchasing a second home with IRA funds:

1.    Vacation home is purchased and held in a self-directed IRA for investment purposes only.

This scenario is the simplest. Existing IRA or 401k funds are used to fund the investment account. The IRA directly owns the property and receives special tax treatment by the IRS.

PROS:  If you love this home and this area, chances are others will too. Vacation homes in desirable locations can be valuable investments. The property may be rented out to vacationers and earned income grows tax-deferred or tax free in the IRA. Many investors also enjoy holding hard assets like real estate in addition to or instead of paper assets as part of their portfolio.

CONS:  You cannot personally use any real estate owned by your IRA account. This second home would be purely for investment purposes. The IRA must pay all expenses associated with the vacation home.

IMPORTANT CONSIDERATIONS:
Compare the return on investment for the vacation home, whether from rental or resale to the return on investments currently held by your retirement account. If cashflow and/or returns on the vacation home are higher, it is probably worth looking at the investment as a potential option for your IRA/401k plan. 

2.    Buy the property now and plan to live there after you retire.

Up to age 59 ½ this option would work identically to Option 1 above. At age 59 ½ you can elect to take a percentage (up to 100%) of ownership in the IRA-owned property in lieu of cash distributions from the IRA. Once you have distributed 100% ownership, you are permitted to use the property as a vacation or primary home.

PROS: Purchasing the property now protects your ability to own the property at retirement. As real estate in popular resort areas continues to rapidly rise, you will have locked in your price at today’s cost.

CONS:  This strategy requires patience. You cannot personally use the property until you have distributed 100% ownership after age 59 ½.

IMPORTANT CONSIDERATIONS:
Taking the property distributions can take time. Talk with your advisors and make sure that you are willing to wait the necessary time.


3.    Secure a mortgage using your IRA and make mortgage payments via IRA distributions using the 72t exemption, which eliminates the 10% early withdrawl penalty.

This scenario is the most complex and will require consulting with a team of professionals to execute properly.  Essentially, the IRA invests in an annuity or other investment with guaranteed payments or stable cashflow.  As money flows into the IRA account from the annuity or other investment, payments are received as a distribution (without penalty) by the IRA holder. These distributions are used to pay the mortgage on the second home, which is held directly by the individual, NOT by the IRA account. Contact our office for a follow-up consult or for a report on 72t exemptions or visit 72t.NewDirectionIRA.com

PROS: You can begin using the property immediately as it is owned directly by you. This strategy provides investment capital for investors with IRA balances that are larger than personal cash savings.

CONS: Investor must be 59 ½ or older in order to take advantage of a 72t exemption. Since the property is owned directly by you and not the IRA, you lose all of the tax advantages of IRA-owned properties.  As a result, taxes apply to the sale of the property as well as the rental income. Income tax is paid on the distributions used to pay the property mortgage.

IMPORTANT CONSIDERATIONS:
You must already have enough wealth to create the annuity providing guaranteed payouts substantial enough to pay the property mortgage.

Buying property using an IRA/401k not only provides critical investment capital, it also has associated tax advantages.

Land in an IRA

More and more investors have been turning to real estate as a way to diversify their retirement portfolios.  Everything from pre-construction condominiums and rental properties to rehabs and lease options are being held inside of IRAs and 401(k) plans. With larger contribution limits and more than $3 trillion currently in retirement plans, investors are now able to look outside the realm of stocks and mutual funds into assets such as real property. Though investors continue to become more sophisticated in their real estate transactions, undeveloped land remains a clear-cut favorite among IRAs and other retirement plans. The simplicity of raw land provides investors with the opportunity to diversify into real estate, without the headaches of upkeep. 

The obvious upside to adding real property to a retirement plan is diversification.  Real estate has long provided investors a way to offset fluctuations in the securities market.  Over the years, millions of investors have utilized this diversification strategy in their personal portfolios, yet only recently have they started implementing this method within their retirement plans.  One of the reasons why less than 3% of all retirement funds are being invested in real property is the “idea” that managing the asset is difficult.  An attractive attribute to land, is its simplicity.   Land truly provides investors with opportunity to take part in the real estate market, without the headaches of upkeep and unforeseen expenses. 

Keep in mind that when a retirement plan holds a piece of real property, all the expenses involved must be paid for by the plan. Simply put, if an IRA owns a rental property, then the IRA must pay for all of the repair and upkeep of that unit. Investors who self direct their retirement plans into assets like real estate will have to be more involved than those who just turn their accounts over to a Brokerage house. 

However, raw land offers a low maintenance way to invest in real estate.  Land has only one relatively predictable expense in annual property taxes. Of course you could lease out your land to a farmer or a timber company and there may be additional expenses.  But for most parcels of land, property taxes are the only expense.  An investor can diversify part of their retirement portfolio into a parcel of a land and not have to worry about any unexpected repairs or cost. 

Any economist or financial advisor will tell you appreciation is driven by supply and demand.  There is a simple truth when it comes to land—there is only so much. The supply is somewhat fixed, especially when it comes to desired land around mountains, waterways and growing metropolitans.

The goal of a retirement plan is to build up your own nest egg through wise investments.  Diversification is the key to any successful portfolio.  Understanding all of your investment choices will only make you a smarter investor.  When it comes to diversifying into real estate, raw land is about as close to a mutual fund as you will find.  It’s an asset that can be purchased and held for the long term, without the worry of unexpected repairs or expenses.  Whether it’s a lot in a planned development near Destin, Florida or a large track of farm land outside of Topeka, Kansas; land provides a simple way to diversify a stock heavy portfolio.