Using a Real Estate Self Directed IRA to Make Real Estate Income

Creating real estate income is something many investors have come to view as a basic portfolio ingredient. Whether you are in the accumulation phase or retirement phase of your life, betting on the paltry bond market for income has become frustrating at best. Many investors do not want to expose their portfolios to the risk of a volatile stock market either, though. Thus, many turn to real estate as a source of retirement income and historical capital appreciation. What many investors do not understand is that by holding real estate in a self-directed IRA, investment returns can be sheltered under the tax-advantaged umbrella associated with retirement plans. A self directed IRA removes one major real estate profit loss – taxes on capital gains. 

However it also shelters rental income by allowing you to distribute funds on a more precise basis from year to year. Until the age of 70.5, you determine when and how much is distributed from your IRA. Here are a few questions to consider before purchasing rental property outright:

·         Am I able to manage the property myself and be “landlord”? It’s perfectly acceptable for an IRA holder to manage their own rental property however there are certain limitations that apply. You may act as “landlord” but only from a decision making capacity. Any repairs or improvements made to the property must be contracted to non-disqualified parties and paid for by the IRA in proportion to ownership. 

·         Does my IRA have a large pool of available liquidity? Many investors gravitate toward their IRAs as a way to tap a large amount of cash, which lends itself easily to cash purchases of real estate.  If your IRA is highly illiquid, or if the liquid portion isn’t sufficient to purchase property outright, you may need to consider other strategies such as financing through a non-recourse loan or partnering your IRA funds with another entity. 

·         Is my plan to rent or lease my real estate to the general public? If you intend to live in a rental property and directly benefit from the space or lease out your real estate to a close relative, the transaction is considered prohibited and cannot be executed in an IRA. Any real estate income received under the qualified umbrella of an IRA must be from a disinterested third party. 

Holding real estate in a self-directed IRA gives investors the ability to own all types of real estate. If all goes as planned, your ability to generate regular, long-term real estate income during retirement will be greatly enhanced by the substantial unrealized gains achieved through years of tax-deferred growth. 

Not all IRA providers are created equal and the vast majority have no experience whatsoever with self-directed IRA real estate transactions. New Direction IRA encourages any investor considering a self-directed IRA to increase real estate income during retirement to weigh all options carefully. Our team of IRA specialists are here to help and answer any questions you have.

Real Estate IRA Fees

One of the main reasons people think Self-Directed IRAs aren’t worthwhile is because of the fees associated with them. However, the fees associated with SDIRAs are usually favorable when compared to fees you’d be assessed on an IRA with publicly-traded securities and at any brokerage house.

At New Direction IRA, we disclose our fees up front so account holder know exactly what they will pay and what they are paying for.

Let’s look at our NDIRA real estate IRA fees, which includes FREE online bill pay:

Application Fee: $50 (One time only when an IRA is opened)
Transaction Fee: $250 (Per purchase/sale/exchange of real estate)
Annual Fee Per Property: $295 (Other fee options available)
Bank Wire: $30 (Per outgoing wire)
Overnight mail: $30 (Per mailing)
Outgoing check fee: $10 (Per check we print and mail.)

Compare that to what you’d pay at another IRA or SDIRA provider and you’ll find it’s lower than most and comparable to all. The reason we’re able to keep our fees low is because we base it on the actual work we do—not a percentage. Also, no one at NDIRA works on commission nor do we sell investments so we are really working for you.

Our fees are only assessed when  your account activity necessitates it. In addition, we offer free SDIRA education and our client representatives are on hand to answer your questions and make your IRA acquisition process a smooth one.

With an NDIRA account, you can also enjoy industry-best technology that gives you more bang for your buck with our online client portal, myDirection®. You can make free online bill payments and pay a low, flat annual fee while checking account activity through myDirection®.  There, you can easily and quickly make payments for things like taxes, insurance, HOA fees, and more for free.

Lastly we offer two separate annual fee schedules for you to choose which is most economical for you and your account. One option assesses fees based on how many assets you have in your account while the other bases fees on your total account value. For more information, visit http://www.newdirectionira.com/real_estate_ira.php.

Real Estate IRA Investing FAQ

Can I buy real estate in my Retirement Plan?

Yes, the IRS actually places very few limits on what you may buy with your IRA retirement funds. It is your IRA custodian who has put those limits on your retirement account. Truly self-directed IRAs allow you, the investor, to choose your investments.

Can I borrow funds to buy real estate in my IRA? Can my IRA get a mortgage?

IRAs can invest in all types of real estate!

Yes, many banks have discovered the demand by IRA owners to finance real estate purchases in their IRAs. Banks continue to develop products specifically for IRAs and other plans. You’ll need a non-recourse loan, which tend to have higher down payment requirements than those for personal homes, but these loan types are available at many banks.

Do I need an LLC to purchase real estate with my IRA?

An LLC may be used to purchase real estate, but it is not required. Your IRA can purchase a property in the very same way as you would personally. This is the most common way real estate is purchased and in this situation the property is simply titled to your IRA.
 
Do I need to use a special broker and title company?

No special broker or title company are required—you can use the same ones you used to buy your current home or any other broker. However, using a broker that is familiar with this process may be helpful buy it is not required.
 
Can I repair the property myself?

You may not personally do any work on the property and neither can any other disqualified persons (IRA holder, his spouse, his parents and grandparents, children and grandchildren, their spouses, certain fiduciaries and any entity owned or operated by a disqualified person. Work can be done by anyone else and you still have control over what you want them to do. For instance, you can’t personally paint the walls but you can tell the painter how you want the house painted.
 
Can I partner my IRA with my personal funds? Who else can I partner with?

If you cannot afford the investment property you are interested in you have many options. One option is to partner with yourself. For example your IRA can own 50% and you can personally own 50% (note: even if you personally own 99% of the property you are still prohibited from living in it or using the property.) You may also partner with someone else’s personal or IRA funds; the disqualified persons rule does not apply here so you may partner with your spouse, parent, child, friend, or whomever. There is no limit to how many people you can partner with. The percent of ownership cannot be changed once the investment is made.
 
Do I have to pay capital gains taxes if I sell the property?

Because the property is owned within a tax deferred (Traditional IRA) or tax free (ROTH IRA) plan no capital gains taxes need to be paid.

Can I take property as a distribution and then live in it?

Yes, after you reach 59.5 years of age you may choose to take the property as a distribution from your IRA. Once the property is 100 percent in your possession, you are free to use the property as you wish.

Unrelated Business Income Tax (UBIT): What is it and Why you should embrace it

UBIT may be an indicator of investment profits

If there ever was a subject that will stop an accountant is his or her tracks it is UBIT, which stands for unrelated business income tax. Many investors shy away from certain IRA investments out of fear that UBIT will take out a big chunk of their earnings. But the truth is that these investors are misinformed about the tax.

To start, UBIT was initially placed on some taxpayers to “level the playing field” for certain businesses. The best example of how UBIT is used is for the competition between a non-profit and a for-profit enterprise. The college bookstore sells books to students and others within the structure of their “non-profit” umbrella. The college bookstore, because it is non-profit, is not taxed the same way as a for-profit enterprise. A non-profit does not pay taxes on most operations and therefore can afford to sell books at a lower cost than the for-profit store across the street. Since both the college bookstore and the for-profit bookstore are competing for the same customers, the college bookstore has the advantage of being treated differently for tax purposes and the advantage of this preferential tax treatment may allow the college bookstore to sell their books for less, thus attracting customers away from the for-profit store.

This is where UBIT comes into play. The government has placed a tax burden on the non-profit enterprise for running a business, i.e. selling books, under the main business of running a college. This same philosophy and set of rules is applied to an IRA’s investment in real estate when there is debt related to the purchase of that real estate. So what is bothering the accountants among us?

• The tax rate for UBIT is high, ranging from 26% to 34%.
• Calculation of this tax is, for those not familiar with the rules, complicated.

These issues are resolved, however, when the investor realizes that the tax allows for greater for overall gains because the account is allowed to use debt-leverage. A good Self-Directed IRA provider will be able to clear up any questions about calculating UBIT and make the process easy.

When debating the pros and cons of using leverage within an IRA to purchase an income property, the questions should never be “How do I avoid UBIT?” but rather “How much will the IRA grow using debt leverage and paying UBIT?” and “What is the resulting rate of return within my IRA?” The other due diligence items such as physical condition of the property as well as questions on the ability of the cash
stream to service the loan and pay expenses, including UBIT, should also be taken into consideration.

Dismissing an investment because of the potential payment of taxes should never be a deal killer. Consult with your legal and tax advisors regarding investments involving potential UBIT within your IRA.

For information or videos about UBIT and other self-directed IRA issues, visit www.newdirectionira.com.

How to help a cousin buy a home with your Real Estate IRA

One of our New Direction IRA client representatives recently spoke with a prospective client who asked us to frame some ways for his IRA to help a cousin buy a home. The cousin has a good job, but he wasn’t sure about his credit rating nor did he have the money for a down payment. We spent some time talking about the ways that IRAs can participate in real estate and the IRS rules associated with that participation. Below is an excerpt that was sent to the cousin to get the ball rolling. If you are in a similar situation, perhaps this may help you get your thoughts together.

Scenario 1 – My IRA buys the house (the property would literally be deeded to the IRA). It secures a non-recourse loan to do this. Typically, a lender will want 30-40% down. So our max purchase price would be about $150K I am guessing. You would pay rent to the IRA or we can set up a rent-to-own agreement. This set-up, depending on the purchase price might leave me with little cash; so, you may need to pay for any unexpected repairs, which of course, would come off the rent or be recognized in some way. The advantages to this method is that you would not have any initial cost and would not have to qualify for financing. And, you could buy my IRA out whenever it was feasible for you.

Scenario 2 – We buy the house as tenants-in-common. My IRA and you are the deed holders, each owning a percentage of the house. This can be kind of fluid but the basic idea might be that I put in the ~$50K, and you come up with the rest. If you need financing for your part, the collateral for the loan would have to be something other than the house. It would also be helpful for you to let me know what your exit strategy might be. In this set-up, I really just contribute the IRA money in exchange for a percentage ownership in the house, but from that point, pretty much all the financial burden would fall on you.

Scenario 3 – I can simply loan you the money that I have available and we can set up the rate, term, and such in a way that is financially possible for you. Like interest only for several years, with a balloon payment down the road or some such. This set-up would mean that you are the deed holder, and the financing would be whatever you can work out.

Because you are a non-disqualified person to my IRA, we have a good deal of flexibility in how we set this up. In part, it will come down to how you want to play it and what your financial options are. One thing that I will mention is that my IRA’s participation always needs to be titled as the IRA. The important thing is to not put just my name on an offer or any type of legal document.

As a point of clarification, disqualified persons to an IRA include the IRA holder, their spouse, and lineal ascendants and descendants (and their spouses). However, the sides of the family tree, siblings, aunts and uncles, cousins, etc. are not disqualified persons.