Are you a candidate?
A unique subset of property investors are those that comprise the niche utilizing their Individual Retirement Account (IRA) to fund new property acquisitions. This subset is made up of very savvy investors, who are unafraid of the risks of IRA investing in real estate, simply because they know all the inherent risks. They also check with their tax advisor (as should you) before attempting to use IRA funds to purchase investment property. They know that this is the best way to protect yourself before beginning any program of investing in real estate using your IRA funds.
Self-directed IRA’s
The actual vehicle used to purchase investment real estate with an IRA is called a self-directed IRA. It differs greatly from a traditional or Roth IRA in that it is set up specifically to fund outside investments (be they real estate or otherwise). The chief benefit? Naturally, deferring paying tax on your positive rental income, of course! And like all other forms of investment property, you can leverage them to increase your real estate portfolio. The double benefit of tax deferment along with the ability to leverage makes a self-directed IRA a very attractive financing tool for savvy property investors.
Passivity – the integral part of the plan
In order to retain the tax advantages afforded you by a self-directed IRA, you’ll need to make sure the investment is “passive” income. This means you can only use the investment to rent to others. It can’t be used for yourself, or other family members either. Each tenant has to rent from you in an “arms-length” way. In addition, and this is a real kicker, you must never comingle your own personal funds with the rental property you’re buying with your self-directed IRA. That also means, only funds from that IRA can be used to pay expenses on the building, over and above your rental income from that same building. The rent that building throws off should be used exclusively to pay for all your property manager fees, renovations, repairs and basic maintenance expenses on that building. You can’t mix the funds with any other building you own that was not bought with funds from your self-directed IRA!
Taking funds out at any time? Nope.
Using self-directed IRA funds to purchase investment property also means you must abide by the rules of the IRA at all times. This includes the provision that you cannot take funds from your investment property out at any time. While the money earned is yours, it must stay in the IRA, and there are set time frames for removing funds (IRA withdrawals) as well as distributions. In order to keep the tax advantage of the IRA, you must stick to these rules. Otherwise, you will lose your IRA status – and all of its tax advantages as well.
Some key elements to remember
There are several important things to remember when acquiring investment property using a self-directed IRA. Foremost among them is the fact that all costs incurred with the acquisition of the real estate investment must come exclusively from the IRA. Don’t even think of comingling funds with other assets. Any deposits or binders on a property need to be coming directly from the IRA. In addition, you’ll need to leave a large amount of reserve capital within the IRA. Any new (and especially unexpected) expenses that arise with your new property acquisition have to be borne exclusively from the proceeds of the IRA, and not any other personal funds. As mentioned above, always check with your tax advisor before undertaking any property investment using your IRA funds.
photos courtesy of theeffinglife.com, inside-real-estate.com, wellsrealtylaw.com, lifehealthpro.com, wealthcounsel.com, cincinnatireia.com