Have you heard about self direct real estate IRAs and wondered how they work and how to get started?
A real estate IRA provides and alternative to investing in traditional stocks and bonds and allows the account holder to invest in income producing real estate.
Here is a short video from Vantage about the real estate IRA: http://youtu.be/7jMAVKUDb7w
Real estate IRAs are often invested in with cash from the IRA without carrying a mortgage from the IRA or IRA account holder to comply with IRS rules. Per, Business Week and Lewis Braham, "Nor can investors employ a traditional mortgage to finance IRA properties. An IRA account doesn't allow its owner to be held personally liable for any unpaid debt. The only permissible loans are so-called non-recourse loans that use the property itself as collateral. These have higher interest rates than conventional mortgages, and any income earned with the portion of the property owned with this leverage is considered outside the IRA and fully taxable....As a result, most self-directed IRA real estate deals tend to be all-cash. For most people, the lack of easily available leverage creates concentrated portfolios of a handful of properties. That's why experts recommend multi-family rental properties with two to four apartments, instead of single-family rental homes; if you lose one tenant, you still have a second apartment rented."
What is an self directed IRA? According to Wikepedia, "A self-directed Individual Retirement Arrangement is an IRA that allows the account owner to direct the account trustee to make a broader range of investments than other types of IRAs."
There are limitations on the rules for investing in real estate IRAs that may result in penalties. Business Week reports, "Self-directed IRAs are complex legal structures that, if managed incorrectly, can lead to stiff penalties from the Internal Revenue Service. The primary mistake is any appearance of self-dealing, where you benefit financially or otherwise from the property in the account before the minimum distribution age of 59 1/2. That means if your IRA owns real estate, you or any immediate family members can’t live in it or get any rental income from it directly. Otherwise, you could invalidate the status of your IRA account and be subject to a 10 percent tax penalty for the account’s value.
Moreover, all repairs, management and property tax costs must be paid with the IRA’s funds. So you must either have a buffer in the account to pay for unforeseen expenses, or hope that the annual maximum allowable IRA contribution, currently $5,000, will cover costs. You can’t even make repairs by yourself without your own “sweat equity” being considered a contribution to the account."
Some investors keep 5 percent to 10 percent of their property’s value in liquid securities such as cash or bonds to cover future repairs.
An investor, will need to choose a custodian to invest their self directed IRA assets into before purchasing a property. The custodian does not determine the value of the real estate purchase. The IRA investor makes these decisions. As Business Week reports, "Perhaps the biggest risk of self-directed IRAs isn't tenants bolting or tax twists but what you choose to put into it." Choose a Realtor that can help you determine a good property for purchase, do your homework and look at costs to bring the property to maket and manage the rental income. If you choose correctly there is a good return in a real estate IRA as opposted to the traditional stock and bond portfolios and the risk associated with those traditional investments.
For more information, check with your accountant and financial advisors.
Jeffrey Masich, Realtor, GRI, MBA