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Do’s & Don’ts of Investing in Real Estate with an IRA

This article is designed to be a launching pad for readers to begin their exploration of real estate IRAs.  It can be somewhat complicated and everyone’s situation is unique so be sure to talk with your competent advisors before you take any action.

Most companies that hold individual retirement accounts are not geared up to handle physical real estate for an investment.  When people ask investment advisors if you can buy real estate with the funds in their IRA they say no.  This is not true.  You can own real estate in your IRA just a regular investment company.

First and foremost:  A retirement account (traditional IRA, Roth IRA, Simple IRA, SEP, Keogh, 401k, etc.) is not an investment.  It is simply a special account that holds your investments.  Most people believe they can only invest in mutual funds, stocks and bonds.  The truth is that your IRA can invest in many other types of investments such as commodity futures and options to yes, REAL ESTATE.

There are specific rules as to what you can and cannot do with your real estate IRA.  Keep in mind it is the self directed IRA that buys, owns and sells the property – not you personally.  You do not withdraw the money from the IRA to buy the property; the custodian buys the property in the name of your new self directed real estate IRA.

Do’s:

  1. Your real estate IRA can buy and sell many types of real estate including raw land, rental property, condos, fixer-uppers, commercial properties, lakeshore, etc.
  2. The property can be rented but the rental income is to be paid into your IRA, not to you.
  3. All of the expenses of renting and operating the property must flow in and out of your self directed real estate IRA.
  4. It is possible to finance a property that is owned by your IRA but the financing must be in the form of a non-recourse loan.  This can be tricky because most banks will not set up a non-recourse loan although I have talked to a few different banks and with a proper down payment they will work at setting up a loan for this type of investment.

Don’ts:

  1. Your real estate IRA cannot buy a property that you, your spouse, or certain family members already own.  Likewise, your real estate IRA cannot sell a property it owns to you or your spouse.
  2. You, your spouse or certain family members cannot have any personal use of the property owned by your real estate IRA.
  3. Your IRA cannot lease the property to your business.  Your business cannot use or occupy any part of the property.

Is a real estate IRA right for you?  The answer depends on the type of real estate and your unique situation.

If you decide that investing in real estate with your IRA is something you want to do there are a few steps.  First set up a self directed retirement account with a company/custodian that specialized in real estate IRA’s.  This is a relatively easy process and can be done by either establishing a new account or rolling over the assets of an existing account.  You’ll want to be sure that there are no surrender charges for rolling over an existing account.  Once you have set up your self directed IRA with a custodian that can handle real estate you may ask “now what?”

You already know your real estate IRA cannot own property that is used by you, certain family members or your business. Therefore, primary residences, second homes and vacation homes are not candidates. In addition, a rental property that produces tax shelter from depreciation deductions would probably not be a good fit because the tax shelter would go to waste in your retirement account.

Other types of real estate, such as raw land, fixer-uppers, and non-leveraged rental properties, are perfect candidates. The profit from these investments would be taxed if you owned the property personally. However, if your real estate IRA buys owns and sells the property, the profit would compound in your IRA tax-deferred (or tax-free if it’s a Roth IRA).

Before your IRA buys any property, you’ve got to understand how real estate works. There’s a lot to it. Make a commitment to learn how to analyze a property before you buy it, including operating expenses and management considerations. Study the financial benefits such as cash flow, depreciation and appreciation. Learn how to determine cap rates, cash on cash and other rates of return. And so on. The more you know, the better your chance of success.

Remember that real estate IRAs are a specialty and not every retirement account administrator/custodian is geared up to handle them.

Bill currently is a partner in a commodity brokerage firm called First Avenue Trading Co that he started in October 2001.   Bill Currently owns income producing property in Moorhead, MN and Mitchell, Dell Rapids and Sioux Falls, SD.  Bill is a native of Sioux Falls and has a wife, Megan and two girls ages 2 and 4.  In his free time Bill enjoys spending time with his family; camping, golfing, skiing and biking.

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