Real estate investments remain the number one acquisition of self-directed IRA owners. Real estate has proven itself over and over again to be a viable long or short-term investment, depending on what your plans are for the property. In the years since the housing market crashed investors with adequate funding were able to acquire these holdings at great prices to build wealth in their portfolios. Some performed rehab-and-flips to make quick returns. Others purchased property to use for long-term rental income, or to sell at a much later date in hopes of higher profit margins. Property worth is known to bounce back eventually and investors acquainted with the market are equipped to capitalize on the potential gains.
IRAs that hold real estate as assets are commonly called real estate IRAs. While the most common asset is an actual piece of property, investments permissible in these plans include a myriad of other holdings the average individual might not realize.
Examples of investments in a real estate IRA include:
- Rental property (apartments, condominiums, duplexes)
- Single-family homes
- Commercial property (office buildings, retail outlets)
- Raw or improved land
- Offshore property
- Tax lien certificates and tangible assets deeds
- Mortgage notes and construction loans
- Trust deeds
- Building bonds
Investors who are familiar with the ins-and-outs of any permissible holding can put their knowledge to work and acquire those assets to grow wealth for retirement. Once you make the decision as to which real estate-related assets you are interested in, you can use your self-directed plan to purchase them.
Funding investments in a real estate IRA
There are several different ways to purchase assets using your IRA.
- If enough funds are available, your IRA can fund the desired venture.
- Your IRA can partner with another person or entity to pool investment funds.
- Your IRA can acquire a non-recourse loan.
If your IRA acquires a non-recourse loan to help purchase an investment, it’s important to understand the account may be subject to Unrelated Debt Financed Income (UDFI) tax, per IRC 514. This tax has to be paid by the IRA and is determined by the largest amount of debt carried by the plan for the previous 12 months. Unrelated Business Income Tax (UBIT), IRC 598, might also be owed when a property is leveraged or acquired via partnerships or other vehicles such as an LLC.
It is critical to consult your tax professional regarding UDFI and UBIT to ensure proper calculation and payment. Failure to properly report and pay UDFI and UBIT can have disastrous consequences in terms of penalties or even disqualification of your IRA.
Assignment of ownership of investments in your IRA
Self-directed IRAs allow the account owner total control in choosing investments. However, it’s important to understand that at the end of the day, the IRA owns the asset and all investments are titled in the name of the IRA. Additionally, all income and expenses must flow in and out of the IRA account. Plan owners are not allowed to receive income associated with the account; all bills are to be paid by the IRA.
You may want to vacation in that awesome rental property your real estate IRA owns, but don’t. This is just one example of a prohibited transaction regarding your IRA. Understand clearly that any gains related to property owned by your IRA are to benefit you upon your retirement and not one minute before.
- You may not personally rent or vacation in a property owned by your IRA.
- Disqualified persons may not vacation in or rent a property owned by your IRA.
- Your IRA not may not purchase a property from you or sell a property to you or any disqualified person.
- Repairs to property cannot be performed by the account owner but by a qualified third party.
Exactly who is considered a disqualified person?
- The IRA holder and his or her spouse
- The IRA holder’s lineal descendants (children, grandparents, etc.) & their spouses
- The IRA holder’s lineal ascendants (parents, grandparents, etc.)
- Investment advisers, managers and fiduciaries
- Any corporation, partnership, trust, or estate in which disqualified persons have a 50 percent or greater interest
- Anyone providing services to the IRA
The above information provides the basic blueprint for using real estate IRAs to their fullest potential. Although the real estate market is slowly but surely rebounding, property costs remain relatively low and the right investment can add diversity and build wealth in your retirement portfolio. Just remember—whether buying property or investing in other options such as tax liens or mortgage notes, the success of your investments depends on your maintaining your account properly, in accordance to IRS rules and regulations.
For more information regarding self-directing retirement plans, please contact us.