Today’s interesting real estate market is making for some great opportunities. With the power of IRAs, ALL GAINS INSIDE AN IRA ACCOUNT ARE TAX FREE. What a time to buy at historically low prices and reap the benefits tax free in the future!
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 the 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.
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.
With over 25 years of experience, Advanta provides clients with education and support to put their retirement plan to work for them through real estate IRAs.
Types of Property Your IRA 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)
Important Rules 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 the custodian or the Administrator. Your IRA funds never leave the IRA. Your IRA actually owns the asset. Many people think the money is distributed and is taxable first; this is not true. Just as your IRA can own stocks, it owns the real estate.
- Percentage Ownership – Real Estate can be purchased 100% by the IRA account or just a percentage interest in real estate as Tenants in Common (i.e. Robert J. Jones 50% Undivided Interest and AdvantaIRA Trust, LLC f.b.o. William Bush IRA #12345 50% Undivided Interest)
- You cannot Buy/Sell/Lease your Real Estate from a Disqualified Person (see below) – 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.
- 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.
- IRA Assets can 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; UBITax 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 United States.
How to Purchase Real Estate in an IRA?
This is one of the most common questions that Midland receives. How do I buy the property in my IRA?
Purchasing real estate in your IRA isn’t that much different from a normal purchase of an investment property. There are a few additional steps as the following process shows:
- Open an account at Midland IRA and fund the account through a contribution, transfer, or rollover.
- Identify the investment property that you wish to purchase with your IRA. Make sure that the property adheres to all of the rules of Self Directed IRAs, and will not be a prohibited transaction. Title of Buyer on contract should be listed as “Midland IRA FBO [Your Name] IRA #XXXXX”
- Complete a Buy Direction Letter that is supplied by Midland IRA. Midland will work with the closing agent from this point.
- Review and approve all closing documents. For example, check that correct titles are on all documents—e.g., “Midland IRA FBO [Your Name] IRA# XXXXX”
- Ensure that all income and expenses pertaining to the property flow through the IRA.
When you’re ready to sell the property, Midland provides the necessary paperwork and works with you and your title company/closing attorney to complete the transaction. All proceeds from the sale are tax free, and go back into your IRA.
For IRAs or 401(k)s, Who is considered a disqualified person:
- The IRA holder and his or her 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)
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 persons holders are not allowed.
For example, an IRA holder may not:
- Borrow money from their own IRA
- Sell, exchange or lease 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
Cash Flow in a Self-Directed IRA – 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, “Midland IRA FBO Client Name/Acct #”. 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 sign the invoice and fax to our office. We cut checks 2-3 times per week and payments are processed very quickly. 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. Instead of mailing it to the county, they mail it to Midland. Midland then cuts a check for the IRA portion and mails the two checks in together.
Different Ways to Buy Real Estate in an IRA
Typically, Real Estate can be purchased 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 IRA FBO John Doe IRA #12345. 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 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 your father to buy the other half. The property would be titled Midland IRA FBO John Doe IRA #12345 50% Undivided Interest and Dad Doe 50% Undivided Interest. This is called Interest in Co Tenancy or Tenants in common. All Income and expense would be prorated based on the owner percentage. In this example all gains, rents and expense would be split 50/50.
- The Third option is the IRA borrows money to purchase the real estate. An IRA can borrow money. It must receive a nonrecourse loan. This means the IRA holder cannot personally guarantee the loan. Only the property will be used as collateral. Typically, these loans will require a larger down payment, and owner financing will qualify.
There can be taxes owed when real estate in an IRA is leverage. This tax is called unrelated business income tax (UBIT). A calculation would have to be performed annually to see if the tax was due, and if the tax is due, a form 990-T would be filed.
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 the tax. Please consult your accountant for more detail information on UBIT.
Real Estate IRA FAQs
Do I need an LLC to buy Real Estate in an IRA?
No. The answer is almost definitely not. In rare cases an LLC can be a viable option, but typically a custodian or administrator can hold the real estate and save the IRA holder a lot of money. LLCs are good to use when you have multiple real estate assets or rehabs that need a lot of accounting. LLCs can be expensive to set up and usually are not needed. Please feel free to ask which will be the best option for your investment.
If I own a piece of property personally, can my IRA purchase it?
Unfortunately, no. You are considered a disqualified person, and you cannot do business with your IRA. Doing business usually includes a Buy / Sell / Trade from your IRA account. The IRS does not want you to transfer gain to your IRA.
What forms do I need to get started?
You will need the following forms to get started:
- Fee Disclosure
- Transfer form
- Buy Direction Form
All forms are located on our website at MidlandIRA.com or email us at mail@MidlandIRA.com and we will send you a complete packet to get started.
How long does it take to transfer funds from my current custodian?
This is the magic question. Typically it takes two weeks and depends on the efficiency of the previous custodian. Once Midland has your Transfer Form, we will process it within 24 hours. The money will be sent as quickly as the old custodian processes the forms. If the funds are a rush, it is typically best to have the funds wired to Midland. This can save several days.
Where does the money go when I sell a piece of Real Estate in an IRA?
Please note, when you sell a piece of real estate, the money must be returned to your Midland IRA. Midland will work with your closing agent to facilitate the sale. All gains would be tax free from the sale of real estate in an IRA. If you would need money after the sale, it would come from your IRA in the form of a distribution.
Can I do a 1031 Exchange when I sell my Real Estate IRA?
The great part about Real Estate IRAs is that there are no gains inside a retirement plan. There is no need to do a 1031 exchange. All proceeds can be reinvested in to the next piece of real estate. There are no timing rules inside a Real Estate IRA. However Midland does perform 1031 exchanges for properties owned outside an IRA. Please feel free to contact us for more information.
What other types of retirement accounts can I use to buy real estate?
All types of retirement accounts can purchase real estate while Traditional IRAs are the most popular. Real Estate can be purchased with a Roth IRA, SEP IRA, SIMPLE PLAN and an Individual K Plan. 401k plans can purchase real estate if they are set up to do so in the plan documents. SEP IRA, SIMPLE Plans and Indy K plans are best for small business owners. The benefit of the Roth IRA is that all distributions from the account are tax free. For a detailed discussion of retirement plans, please visit our website at MidlandIRA.com.
Case Study (for discussion purposes only)
Bob Jones has $250,000 in a Roth IRA at a national brokerage firm, Dean Water Securities. Bob has seen his IRA go up and down over the last few years and wants more security.
Bob’s Realtor asks him if he has heard of a real estate IRA. Bob was unaware that real estate could be held in his IRA. Bob has owned rental real estate outside his retirement account, and likes the control and stability it can bring. South Florida real estate is currently low in terms of price, so Bob believes it is a good time to buy.
Bob Jones opens up a Real Estate Roth IRA at Midland. Bob completes the following steps, prepares account application and transfer form. Bob has all of his IRA transferred to his new Midland Real Estate IRA. This process includes filling out 4 forms guided by our staff and takes about 2 weeks.
During this time Bob is working with his realtor to look for properties. Bob puts a contract in on two properties, a rental duplex for $125,000 in Cape Coral, and a bank owned property in Fort Myers for $75,000.
Midland will sign the contracts and work with the closing agents on the purchases. The properties will be titled in the name of Midland IRA f.b.o Bob Jones IRA #99999. Bob will rent the duplex. This means that all rent checks will be sent to our Midland office. Any expenses for the duplex will also be paid by our staff from Bob’s IRA. Bob will authorize and submit the bills to Midland who will pay them on behalf of the IRA account. This is a long term investment for Bob.
The single family house that was purchased at a deep discount will be sold. Bob has the IRA spend $5,000 to spruce up the property up with new paint, carpet and landscaping. The property is listed with a realtor for $115,000. A contract is obtained for $115,000. Bob will send Midland a Sell Direction Form. Midland will then work with the title company to sell the asset. Bob will approve the closing documents before Midland will sign the final documents.
The proceeds of the sale will be transferred to Bob Jones’ Roth IRA money market. The approximate gain of $ 35,000 (115 – [75+5]) will be tax free to the Roth IRA. When Bob is 59 ½ the money can be withdrawn from the IRA tax free as well.
Now that the cash is back in Bob’s IRA money market, he can go out and purchase another piece of real estate. This is the Power of a Midland Self-Directed Real Estate IRA.
For Real Estate Agents / Brokers
Real Estate IRAs are a great opportunity for real estate professionals to sell more real estate with new and current clients. Most professionals are not taking advantage of this untapped market. Midland is proud to assist local realtors with their sales efforts. If you ever need flyers or information on Real Estate IRAs to send to your clients or include in your newsletter, please feel free to contact us. We have a special realtor tool kit that we can email to you.
Ideas to help Realtors promote Self-Direction:
- Add it to your newsletter – Ask your clients if they know they can purchase real estate with their IRAs. Most clients are unaware that they can use their funds to purchase investment real estate. After you get their attention, let Midland answer their specific questions and get them started. Midland is very confidential and will make sure that your clients are taken care of. Midland does not sell any products; including real estate.
- Add us to your website, we have a special page for real estate IRAs.
- Attend one of our CE Events – We teach continuing education throughout the year and will even teach it in your office for a staff of 10 +. Check www.MidlandIRA.com for more details.
- Be a resource for your clients – There is a lot of money in Retirement Accounts. The value of IRAs is over $4 Trillion, and only 2% is invested in Real Estate. With market volatility, clients are looking for investment solutions they can control.