By Tom Anderson
Investor James Mann was frustrated with the lack of appreciation in the stock market and decided it was time for a different approach.
So he took a rollover IRA from a former employer and put it into a self-directed IRA to buy something “I could see and feel.”
He couldn’t have been happier with the outcome. The rental condo he bought in Reno, Nevada, appreciated more than 50 percent in one year and produced a healthy 6 percent net cash flow.
For many like Mann, the idea of buying real estate with an IRA is as foreign as putting ice cream on a hot dog.
That’s because most advisers and their financial institutions restrict their clients to buying stocks, bonds, mutual funds and/or CDs — the products that most brokerage companies are used to selling.
That’s starting to change, as more people take more control of their retirement portfolio investment selection and allocation.
The flexibility of the IRA for the buy-to-rent real estate investor
A self-directed IRA (SDIRA) account and the freedom of self-directed investing liberates investors (technically, the SDIRA account beneficiary) from the small list of mutual funds choices that their employer’s 401(k) may offer.
The self-directed IRA is legally no different than any other IRA, but has the added benefit of allowing the investor to choose the investments that the IRA will hold.
The rules governing a self-directed IRA allow for a virtually unlimited array of investments from real estate to private company stock and notes to precious metals. The investments can also include a wide range of assets as unusual as a PENSCO client investing in underwater property and the rights to fish certain geographical areas for a specific aquatic species.
The only investments prohibited in an IRA are:
• Settlements from the sale of a life insurance contract (viatical settlements)
• Collectibles (e.g., antique rugs, cars, stamps, furniture, etc.)
• Capital stock in an “S” corporation (solo (k) plans can invest in an S Corporation)
How to invest in buy-to-rent rental property
There are as many ways to invest in real estate, but one of the most intriguing and proven is rental property with opportunities for tax-free or tax-deferred income.
To invest in rental property, investors must have their IRA purchase the rental real estate from an unrelated party – not a direct relative or themselves. Your IRA pays cash for it. You cannot use the real estate for personal reasons while it is in your IRA.
So if you dream of owning a rental condo in Cancun, and the only funds you have to acquire it are in your IRA, you could buy it and rent it, but you cannot spend ANY time in it. The IRS rules are very strict as to prohibited transactions and personal use.
Single-family residences, multiple-unit properties, commercial buildings, storage units, mobile homes, airplane hangars, parking lots, foreign properties – all of these can go into an IRA.
How to purchase a buy-to-rent rental property in your IRA
Purchasing a rental property that goes into your IRA is simple. You either transfer your existing IRA(s) or roll over from your pension plan account to a self-directed custodian. Most of the transfer process can be done online. You find a property, then instruct your custodian to make the deposit and complete the purchase.
Once you’ve completed your IRA application and transfer forms from your successor custodian, the new custodian will accept by signing your transfer form and sending it to your custodian. The custodial company will notify you when your funds are received.
Your new self-directed IRA lets you are shop for a rental property and make an offer on a property that meets your self-directed investment goals. The real estate broker may now draw up a purchase offer in the name of your IRA with the name of the property, DBA and SDIRA account number. You as the beneficiary should sign the purchase offer, as most custodians want to make sure you have reviewed and approved the offer (this is the purpose and spirit of self direction).
Once the custodian receives offer, escrow (from title company or closing attorney) and wiring instructions, the custodian will sign the purchase offer on behalf of your IRA as the buyer, fund and forward the signed documents to the title company.
The final details of how to do buy-to-rent for your IRA
Once the custodian has deposited the earnest money purchase deposit, your broker, title company or attorney will prepare the following closing documents:
• Final contract (again, initialed as read and approved by you) for the custodian’s signature as the buyer on behalf of your IRA with you as the beneficiary of the purchase.
• Escrow statement indicating all costs, contingencies, deposit amounts, pre-paid taxes and the net amount due to the seller from you (your IRA).
• Preliminary title insurance report.
• Evidence of insurance (if required).
• Final funding instructions.
Upon closing, instructions will be made authorizing the custodian to complete the purchase and payment of the balance of the purchase money. Upon beneficiary authorization, the custodian will sign, notarize and return the documents to the title company or attorney’s trust account, concurrently wiring the authorized funds.
The recorded deed is sent back by the county via title company to your custodian, keeping the asset and any funds with the custodian and thereby protecting the beneficiary account tax-deferred status.
Congratulations; your IRA now owns property that must be professionally managed by a property manager that understands how to work with an SDIRA custodian that understands managing rental property for an SDIRA account holder or beneificiary.
About the author:
Tom Anderson has over 44 years of financial services experience focused on trust services and retirement accounts, Tom Anderson mentors and educates investors about the multitude of investment opportunities inherent in self-directed retirement plans and alternative assets. Tom takes special interest in understanding the nuances of prohibited transactions within retirement account investments, and he enjoys helping the baby boomer generation restore wealth to their retirement portfolios by demonstrating how to think ‘outside the box.’ Considered to be one of the top experts in the self-directed industry and frequently quoted in the national media, Tom is currently the President of the self-directed IRA industry association (RITA).
(This perspective is general in nature and is not intended, and may not be relied upon, as an opinion or advice on any legal, tax or investment aspects of IRAs. An IRA owner considering an IRA investment in a private placement or closely held corporation should consult with his or her attorney, tax adviser and CPA before making such investments. PENSCO does not provide tax, legal or financial advice. All rights reserved. Copyright 2013, PENSCO Trust Company)