WHAT IS A SELF-DIRECTED IRA?
A self-directed IRA is not a special type of IRA. The term self-directed simply refers to the way the account is administered and the greater choice of investment options available to the account owner. More conventional retirement accounts are managed on behalf of the client. Self-directed IRAs are invested solely at the discretion of the owner of that account who directs the account administrator (such as Midland Trust) to purchase assets they have completed their own due diligence on. Accounts that can be self-directed include: Traditional, Roth, SEP and SIMPLE IRAs, as well as educational and health savings plans and 401(k)s.
WHAT IS A REAL ESTATE IRA?
Self-directed accounts that hold real estate as assets are commonly called real estate IRAs. The administration and functionality of real estate IRAs is the same as any other self-directed account. Account owners identify real estate-related investments they wish to acquire based on things they know and understand—retaining absolute control over their own funds and acquisitions. Over time, real estate investments have empowered investors by providing a combination of appreciation and income. All income and sale proceeds from owning the property stay within the IRA and can then be reinvested in another property. All profits made by the IRA return into the account tax-deferred (or possibly tax-free). By not paying taxes on the growth, your real estate IRA retains more principal to build income for retirement.
INVESTING IN REAL ESTATE WITH YOUR IRA
A self-directed IRA or real estate IRA gives you the freedom to invest in non-traditional assets, such as single-family and multi-unit homes, apartment buildings, co-ops, condominiums, improved or unimproved land (leveraged or unleveraged), commercial property, and more.
Why Real Estate IRAs? All of the proceeds from the sale of a piece of real estate in an IRA can be reinvested into your next property without giving a large percentage to the government as federal and state taxes. This will allow you to have more principal for you to grow for your retirement.
Over time, real estate investments have afforded many people with a powerful combination of appreciation and income. The purchase of real estate through a self-directed retirement plan is a popular investor choice for this and other reasons. Read our article “3 Reasons to Invest in Real Estate Using a Self-Directed IRA.”
With over 25 years of experience, Midland provides clients with education and support to put their retirement plan to work for them through real estate IRAs.
TYPES OF PROPERTY YOU CAN OWN
- Single-family and multi-unit homes
- Apartment buildings
- Commercial property
- Improved or unimproved land (leveraged or unleveraged)
- Trust Deeds and Tenant in Common Interests (TICs)
TERMS TO KNOW FOR SELF-DIRECTED REAL ESTATE IRAS
Here are some basic terms you should understand as you begin to educate yourself on buying real estate in your retirement account.
An account in which you choose which investments you want to hold that are not publicly traded in the stock market (Ex. real estate, private equity, private lending, and more).
These parties include the IRA holder personally, a spouse, any lineal ascendants or descendants, or an entity in which the previous mentioned parties own 50% or more. You cannot buy, sell, or lease a property to any Disqualified Party.
The company that holds custody to your retirement assets and keeps the account in a tax deferred/tax-free status.
The property you buy within an IRA is for investment purposes only. There can be no personal use of the property. You cannot buy a personal residence (primary or vacation home) or an office building you work out of. This extends to the disqualified parties mentioned above.
The IRS is clear that certain transactions are not allowed in retirement accounts including borrowing money from it or using it to secure a loan.
The purchaser for the property must be in the name of your IRA. This vesting should listed on both the contract and all closing documents: Midland Trust Company As Custodian FBO [Client Name # Client Account Number].
If the contract is in your name personally, a new contract will need to be drafted to list the IRA vesting. No assignments or amendments to contracts are accepted.
If Earnest Money is required, Midland will need to issue the funds. A purchase request for funds with the contract is all that is necessary.
All related expenses must be paid directly from the IRA account. Your IRA cannot reimburse you for any payments made personally. Remember, you do not own the real estate personally; your Midland account owns it and therefore the funds must come from that account.
Examples of qualified expenses for an IRA owned property are: utilities, repairs, improvements, HOA dues, taxes and insurance.
HOW TO PURCHASE REAL ESTATE WITH AN IRA
DIFFERENT WAYS TO BUY REAL ESTATE IN AN IRA
Typically, Real Estate can be purchased in many ways in an IRA account. The most popular ways are the following three.
- Cash Purchase – The IRA account has enough cash to purchase 100% of the asset. The asset will be titled in the name of Midland Trust Company As Custodian FBO John Doe IRA #1234567. The IRA is responsible for 100% of the income and expenses. All gains are tax-free in the IRA account.
- Partner up with a Friend, Associate, Family Member or Yourself. Just because you don’t have enough cash in your IRA does not mean you cannot buy real estate. On a new purchase, family members are not considered disqualified. Many clients only buy a percentage interest in the piece of real estate.
For Example: Let’s assume you are buying a rental duplex for $100,000 and your IRA only has $50,000. You can partner with yourself to buy the other half. The property would be titled Midland Trust Company As Custodian FBO John Doe IRA #1234567 for an Undivided 50% Interest and John Doe for an Undivided 50% Interest. This is called a Tenants in common purchase. All Income and expenses would be prorated based on the ownership percentage. In this example, all gains, rents, and expenses would be split 50/50.
- Use a Mortgage. An IRA can borrow money using a non-recourse loan. This means the IRA holder cannot personally guarantee the loan and only the property will be used as collateral. Typically, these loans will require a larger down payment and have a higher interest rate than traditional mortgages.
There can be taxes owed when real estate in an IRA is used as leverage. This tax is called unrelated business income tax (UBIT). The tax is only based on the percentage of the income that was financed. For example, if the asset was leveraged 50%, then 50% of the gain could be subject to teh teax. A calculation would have to be performed annually by a CPA or qualified professional, and if the tax is due, a form 990-T would be filed.
RULES AND REGULATIONS FOR REAL ESTATE IRAS
Title to Assets
When you purchase real estate in a retirement account, the assets will be titled in the name of your IRA. Your IRA actually owns the property and Midland adminsters the asset.
Real Estate can be purchased solely by the IRA account or as a percentage of interest in a property as Tenants in Common (TIC). If you are purchasing a property as TIC, the total closing price must be paid pro-rata. This includes any fees, taxes, and earnest money.
You Cannot Buy/Sell/Lease Your Real Estate From A Disqualified Person
See below for a complete list of disqualified persons. You cannot buy real estate that you already own. You cannot rent to a disqualified person. The rules consider this Self Dealing and it is strictly prohibited.
WHO IS CONSIDERED A DISQUALIFIED PERSON FOR IRAS OR 401(K)S?
- The IRA holder
- The IRA holder’s spouse
- The IRA holder’s lineal descendants, ascendants, and their spouses
- Investment advisors and managers
- Any corporation, partnership, trust, or estate in which the IRA holder has a 50 percent or greater interest
- Anyone providing services to the IRA, such as the trustee or custodian (see IRS Section 4975 for a complete list of prohibited parties credentials)
Real Estate Income and Expenses
All income (rents or sales proceeds) that are produced by the Real Estate IRA must be returned to the IRA cash account. Expenses are treated the same way; all expenses must be paid by the IRA account. If the real estate is owned as a percentage, the IRA would pay the applicable percentage of the expenses.
PROHIBITED TRANSACTIONS IN A SELF-DIRECTED IRA
Self-directed individual retirement accounts provide a great deal of freedom, flexibility, and choice of potential self-directed investments. However, they are also governed by a set of rules that self-directed investors must be aware of and follow.
Some types of self-directed transactions violate the basic intent of your IRA and may subject your account to risks and penalties.
Your retirement plan is intended to benefit you when you retire and not before. Transactions that can be interpreted as providing immediate financial gain to the account holder or other disqualified person holders are not allowed.
For example, an IRA holder may not:
- Borrow money from their own IRA
- Sell, exchange, or lease the property to their IRA
- Receive unreasonable compensation for managing property held by the IRA
- Use their IRA as security for a loan
- Transfer plan income or assets to disqualified persons
- Lend IRA money to disqualified persons
- Extend credit on their IRA to disqualified persons
- Furnish goods, services, or facilities to disqualified persons
- Allow fiduciaries to obtain or use the plan’s income or assets for their own interest
HOW TO HANDLE INCOME OR EXPENSES
Many of the investments that Midland administers require cash coming into or leaving the IRA account. If an IRA owns an investment, any profits (income) related to the investment must be sent to Midland to be deposited back in our client’s account. Renters or payers must make the check payable to, “MTC FBO Client Name and Account Number”. The IRS will not allow funds to be deposited in the IRA owner’s personal account even if the client is planning on reimbursing his/her IRA immediately after the deposit.
Similarly, if an IRA owns an investment, all expenses related to that investment should be paid from the IRA. Our clients cannot make these payments and expect Midland to reimburse them after the fact. When a client has a bill to be paid, they simply log into their portal to request an outgoing payment. The client has the option of having a third-party property manager as well. Midland, at the direction of the client, can fund the property manager, and the manager can handle the expenses/income.
Finally, if an investment is owned partly by the IRA and partly by an individual, the IRA pays its share of expenses and receives its share of income. For example, if there is a 50/50 split on a property and a property tax bill comes due, the client simply writes a check to the county tax collector for their 50% share.
IRA Assets And Finance Purchases
If there is financing involved with an IRA asset, it must be nonrecourse financing (IRA owner cannot personally guarantee the note). Typically, lenders will require larger down payments on nonrecourse loans. The lender can be the seller. Please note there can be tax consequences of financing an asset inside an IRA account; UBIT tax can apply.
No Personal Use
Real Estate owned inside an IRA account must be for investment purposes with no personal use. Also, if you visit that IRA property, you cannot write off the trip nor can you stay in the unit to do maintenance.
Foreign Property Does Qualify
As long as it is investment property, the Real Estate IRA can purchase investments outside of the United States.
TIPS & REMINDERS
A few things to keep in mind when buying real estate in your IRA are as follows:
- If you are getting serious about purchasing property, be sure to get your account opened so you can work to get the funds moved over. This will position you to buy the property you want on time.
- Next, work with our dedicated service team to get your Transfer or Rollover moving so that we can receive the funds on your timeline. Our team will reach out to you after your account is opened to go over the next steps, including setting up your Midland360 account which allows you to manage your account online.
- Get to know the team of dedicated reps at Midland so you have your go-to people behind you when you need a little guidance.
- This summary page is a helpful resource for anyone interested in buying real estate in their IRA.
What is the process for purchasing Real Estate with Midland?
When purchasing real estate in your IRA, it is important to keep in mind that your IRA will be the deeded owner of the property. When you are ready to put in an offer you will want to be sure that your Midland account is listed as the buyer (Midland Trust Company As Custodian FBO [your name] [Midland account #]), so will want to be sure you have your Midland account established first. Midland cannot accept a contract that is in your name personally, nor can Midland accept any addendums or assignments to a contract that initially listed you personally as the buyer.
Once your offer is accepted, Midland will issue the earnest money deposit from your IRA, so be sure to allow time for your Midland account to be funded. Midland will then work with the closing agent to issue the balance due at closing.
Is there a timeline I should be aware of in order to close on a property?
There are several timelines you should be mindful of when it comes to investing in real estate using your IRA. First, let’s go over account funding. If you are transferring funds from another IRA custodian, you will typically want to allow up to 14 business days for your Midland account to be funded. If you are rolling over funds from an employer plan, the timing of the rollover will depend on your plan administrator. If rolling over funds, you may want to check with your plan administrator to find out their standard processing times.
In addition to the time it will take to fund your Midland account, you will also want to be mindful of Midland’s processing timeline. Midland typically requires three business days to review investment documents and issue funds. During this period, Midland will work with you to ensure your IRA is listed properly as well as receive your approval on all investment documents. If you are looking to use your IRA to invest in auction properties, you may consider looking into investing using a Single-Member LLC to ease issuing funds on a tight timeline, as they typically require a deposit within a 24-hour time frame. You can read more on Single-Member LLCs here.
Are there any properties I cannot hold inside my IRA?
The only property that cannot be held by your IRA is one that you or another disqualified person owns personally, or that you plan to rent to a disqualified party. Other than that, any type of property qualifies to be held in an IRA.
Are mortgages allowed for IRA owned properties?
You are not able to secure “traditional” financing when purchasing an IRA owned property, as you cannot personally guarantee the loan. However, it is possible for your IRA to receive financing through a non-recourse loan. With a non-recourse loan, the lender’s only recourse should the IRA default, is the property being purchased. Seller-financing may also be an option, as long as there is no personal guarantee. Income on the financed portion of the property may be subject to Unrelated Debt Financed Income (UDFI) tax (unless the property is held in an Individual 401(k), in which case, this tax is excluded). Should you choose to utilize a non-recourse loan for your IRA purchase, keep in mind that loan payments and taxes incurred will need to be paid for by the IRA.
Can Real Estate held in an IRA be subject to taxes?
Even when held in your IRA, your real estate investment is still subject to taxes. While deferred from capital gains, your IRA will be responsible for paying applicable county and/or state taxes on properties held in your IRA.
If you purchased the property using a non-recourse loan, any income received on the financed portion of the property may be subject to UDFI tax (unless the property is held in an Individual 401(k), in which case, this tax is excluded).
If you are looking to utilize short-term rental platforms, such as AirBNB or VRBO, the income received may be subject to unrelated business income tax (UBIT). UBIT will generally apply if the rental period is less than 7 days, or if the rental period is less than 30 days but significant personal services (such as daily maid services, breakfast, etc.) are provided. Local taxes for short term rentals may also apply. If the rental property is held in an Individual 401(k), UBIT taxes are excluded.
It is always important to consult with a tax professional about the above-mentioned taxes to determine what taxes apply for your situation and what property will work for you.
Can I use my entire Midland account balance to purchase a property?
If you are looking to utilize your entire account balance to purchase a property in your IRA, you will need to be sure you will have access to other qualified funds in order to pay expenses incurred by the property. You cannot pay for IRA incurred expenses personally, payment must be issued from the IRA. Typical expenses include: property taxes, HOA dues, and improvement costs. All repairs also have to be completed by a non-disqualified party (you cannot personally perform repairs), so be sure to factor in the cost of maintenance when considering a property. If the property will not be generating income, you will want to be sure IRA funds are available at Midland or in another retirement account to maintain the asset.
Am I able to partner my IRA and personal funds to purchase a property?
If your IRA does not have sufficient funds for the investment you are interested in, you have several options:
- Partner your IRA funds with your personal funds in a Tenants in Common purchase. The total purchase price, including any fees, will need to be paid pro-rata by each party based on the percentage of ownership.
- Your IRA may also partner with another individual or entity in a Tenants in Common purchase.
- Obtain a non-recourse mortgage that is backed solely by the property being purchased.
Does Midland act as my Property Manager?
Midland does not manage your property or monitor your account for income. Any bill payments must be requested through your Midland360 account to have funds issued from the account. If you are expecting regular rental income from a property, you will be responsible for ensuring that the income is paid by the due date or hiring a third-party manager to do this on your behalf. A property manager can also make the property-related bill payments on your IRA’s behalf by deducting the cost directly from the collected rent. A paid property manager must be a non-disqualified third party.
RESOURCES FOR REAL ESTATE IRAS
The following 5 blog posts are our most helpful resources for those interested in learning more about real estate within their retirement account.
- FAQs about Real Estate IRAs
- Even Small Retirement Accounts can hold Real Estate
- While we did tell you that you cannot live in your investment property, this little gem of an article can tell you the technicality that might just let you do that.
- Rental Property Assets in your IRA discussed here.
- A refresher on Contribution Limits which can affect the size of your potential real estate investment.
REAL ESTATE AGENTS & BROKERS
Real estate is one of the most common investments purchased inside of a self-directed IRA yet only a small percentage of Realtors® know about this opportunity. When an investor uses their IRA to purchase real estate, all of the rental income and sale proceeds from that property are deposited into their retirement account tax-free. This strategy is a tremendous opportunity for Realtors® to help them sell more real estate.
Purchasing real estate using a self-directed IRA isn’t just a strategy to defer taxes on investment real estate, it’s also an alternative source of funding that Realtors® can offer to their clients. Currently, there is over $5 trillion in IRAs, and according to recent projections that number is expected to exceed $8 trillion by 2017. Investors have the option to purchase 100 percent of the investment property inside of their IRA, or they can purchase a portion of the property by having their IRA partner up with another (or several) buyers. For example, they could purchase a percentage of the property personally and a percentage of the property with IRA funds. Moving forward, any income/expenses generated by the investment property would be split according to ownership percentages.