Many people have no idea that their retirement account (IRA, 401-k, etc) can invest in many different types of assets, many of which are not allowed by their current custodian. For instance, if you asked your typical custodian to buy real estate, I’d bet that 99% of them would tell you no. The problem isn’t that the IRS prohibits real-estate. The problem is 99% of the custodians do not want to deal with property tax bills, deeds, and paperwork involved in a real-estate closing. They prefer transactions to be much more automated; transactions where a button is pressed and you suddenly own stock. Investing in assets other than securities has been allowed since the Employee Retirement Act of 1974 (ERISA) was passed. You don’t need a special type of retirement plan. You need a special administrator.
As one of the largest self-directed IRA administrator in the country, I thought it would be interesting to describe some of the investments Midland IRA has seen over the years. This will show the tremendous flexibility of investing through a self-directed account.
Strategy #1: Purchasing Rental Real-Estate for cash
Our most common transaction is a simple purchase of property with IRA funds. IRAs can purchase vacant land, residential, or commercial property. If the IRA owns 100% of the property, then the IRA will receive 100% of any income (i.e. rent/sale) tax-free. We have many clients that use their IRA to purchase a portion of a property. The IRA purchases the property as tenants-in-common with another IRA, another party, or even the IRA owner. All income and expenses get split along the percentage of ownership.
Strategy #2: Purchase, rehab, and resale of Real Estate
Some of our clients do not want to hold property over time, even if it cash flows. Their IRA purchases a property in need of rehabbing at a discount, pays the expense of doing the work, then sells the property 6 months later. Once again, the sale proceeds go back to the IRA tax-free.
Strategy #3: Purchase and Immediate Resale (Flipping)
When the real-estate market is booming, clients who “flip” properties seem to come out of the woodwork. Unlike the previous two examples, flipping is a strategy which allows a client to invest very little cash. For example, a client had his IRA sign a contract and put down a $50,000 deposit on a $500,000 commercial property. Before the property closed, the client found a chain store that would pay $650,000 for the property. On the day of closing, Midland IRA received two sets of documents and a check… one for the purchase at $500,000, one for the sale at $650,000, and a cashier’s check for $200,000 (the initial deposit plus the gain from the sale)… again, tax-free to the IRA.
Strategy #4: Assignments and Options (Getting paid NOT to buy)
Another strategy for building wealth without a significant amount of cash is the use of options and assignments. A Midwestern office had a client that put a burned down property under contract in his daughter’s Coverdell Education Savings Plan account for $100. The seller was just looking to get rid of the property for its lot value of $5,500. The client then used his contacts to find a person that specialized in buying and rehabbing burned out houses. The new buyer was willing to purchase the property for $14,000. At closing, the seller received his $5,500 and the Coverdell ESA received an assignment fee of $8,500. That is an 8,400% return on the initial $100 investment, all tax-free and completed within 30 days! The client then took a tax-free distribution of $3,500 to pay his daughter’s private school tuition.
Strategy #5: Debt Leveraging
Say that again? An IRA can borrow money? Yes, an IRA can borrow money by taking out a non-recourse loan. Midland IRA provides free education on non-recourse loans, but the simple answer is that an IRA can put down a minimum of 35%, finance up to 65% on investment properties that cash flow. The IRA must make the mortgage payment, so the bank is going to want to make sure the cash flow can make the payment.
Strategy #6: Hard Money Lending
About twenty percent of our clients loan money with their IRA. Loans from IRA’s can be made secured by real estate, mobile homes, or anything else. Some people choose to loan on an unsecured basis. As long as the borrower is not a disqualified person to the lending IRA, almost any terms agreed to by the parties are acceptable. At our office, we routinely see hard money loans secured by first liens against real estate with interest at 12%-18% for terms ranging from three months to three years.
Strategy #7: Private Placements
Many clients invest their IRA in private entities, such as private bank stock, a limited partnership or an LLC. The IRA has an equity interest in these entities, and as dividends are paid, the funds flow back (tax-free) to their Midland IRA account. Keep in mind that the IRA needs to be funding a passive investment. The IRS has rules against an IRA investing in a company which the IRA holder (or his family) own more than half of or operate.
Strategy #8: Using OPI (Other People’s Money) to Make Money Now
OK. So you enjoyed reading the examples above, but none of the above apply to you because you do not have a retirement plan OR your retirement plan is tied up with a current employer who will not allow you to invest in non-traditional assets. Well, your time reading this article is not lost. Each of the above examples focused on the possibility that your IRA could be the investor. But what if you are the recipient of the IRA’s investment money? Are you a real-estate investor having a hard time finding funding for your transactions? If you know people with self-directed accounts or people who would move their money to a self-directed account, you can borrow their IRA money and virtually create your own private bank!
Strategy #9: #1,000
What has been discussed above covers about 98% of the transactions our clients perform. That being said, the only restrictions contained in the Internal Revenue Code are that IRAs cannot invest in life insurance contracts or collectibles, so your investment options are almost limitless.
Contact us today and tell us your story. We are hear to listen, educate and offer assistance if and when you are ready to open your account.
Written by Brandon Hall, MBA, CISP (Certified IRA Service Professional), COO Midland Trust.
DISCLAIMER: Midland IRA does not offer investment, tax, financial, or legal advice nor do we endorse any products, investments, or companies that offer such advice and/or investments. All parties are strongly encouraged to perform their own due diligence and consult with the appropriate professional(s) licensed in that area before entering into any type of investment.
*All investments involve risk. There are no guarantees that alternative asset investments will increase returns and minimize losses. Like traditional investments, there are inherent risks of investing in alternative assets and many hold the opportunity to lose most or all money invested.