Real Estate Investing with Self-Directed IRA

Types of Investments with Self-Directed IRA LLC
Advantages of Using a Self-Directed IRA LLC
Using a Loan to Acquire Real Estate
Steps for Establishing a Self-Directed IRA LLC for Real Estate
Legal Rules That Apply When Using Self-Directed IRA LLC to Invest in Real Estate

TYPES OF REAL ESTATE INVESTMENTS WITH SELF-DIRECTED IRA LLC

Unlike traditional IRAs, Self-Directed IRAs allow you to purchase and invest in almost any type of real estate. In fact most self-directed IRA account holders use their Self-Directed IRA to invest in real estate. Real estate tends to be a more stable investment than stocks and bonds, it is tangible, and it helps diversify the IRA owner’s investment portfolios. And like investing in real estate outside of an IRA, you can borrow to purchase the property (must be nonrecourse debt- see below) and can invest in the property using your Self-Directed IRA money along with funds from family members, friends or colleagues. Below is a partial list of allowable real estate investments you can make with your Self-Directed IRA LLC:

  • Residential or commercial real estate
  • Raw land
  • Foreclosure property
  • Mortgages
  • Mortgage pools
  • Deeds
  • Tax liens
  • Domestic real estate
  • Foreign real estate
  • Vacation homes
  • Rental units
  • Condos or co-ops
  • Farm land

ADVANTAGES OF USING A SELF-DIRECTED IRA LLC FOR REAL ESTATE INVESTMENTS

As an alternative to the stock market, income-producing real estate properties can provide consistent income as well as long-term gains through appreciation. There are no limitations on the types of properties that can be held by a Real Estate IRA LLC.

Among the many benefits of using a Self-Directed IRA LLC to make real estate investment are:

  • Tax-deferred income: Using a Self-Directed IRA LLC allows the gains on sale of real estate or the income from rentals to be earned tax-free while held in the LLC. You pay tax only at a future date (when the income is distributed to the account holder). By way of comparison, if property is sold outside the IRA or rental income is earned outside the IRA, taxes are due in the year of sale or rental income is earned.Note: If a Roth IRA is used all income escapes tax forever.
  • Funds Needed to Purchase. IRAs can provide a source of funds to purchase real estate.
  • Use the funds in your Self-Directed IRA LLC with funds from family, friends, or colleagues to buy real estate. As long as the funds are invested in the real estate and not in the LLC, there are few restrictions on using funds from others to invest in the property (the one major restriction is that a recourse loan cannot be made to purchase the property).
  • By virtue of using a LLC with the Self-Directed IRA, you eliminate the delays associated with an IRA custodian enabling you to act quickly when the right real estate investment presents itself.
  • By virtue of using a LLC with the Self-Directed IRA, you eliminate the costs a custodian would charge for a purchase of real estate and for holding the real estate

USING A LOAN TO ACQUIRE REAL ESTATE

If you do not have sufficient funds in your Self-Directed IRA LLC to invest in real estate, or you want to leverage the funds so that you can purchase more real estate with the funds in the LLC, you can use a nonrecourse loan to purchase real estate. There are many companies that specialize in these kinds of loans and IRA Village can assist you in finding a qualified lender.

A nonrecourse loan only uses the property itself as collateral. In the event of a default, the lender can collect on the property and cannot go after the LLC or the Self-Directed IRA.

However, if you use a nonrecourse loan you should be aware of the tax consequences. If a nonrecourse loan is used, tax is due on the profits from the real estate. Some portion of each item of gross income from the property is subject to Unrelated Business Income Tax (“UBIT”). While the UBIT will reduce the after-tax profits from real estate, an investor may still realize more after-tax profits if the funds are leveraged to purchase more real estate than would be possible with just the LLC funds.

STEPS FOR ESTABLISHING A SELF-DIRECTED IRA LLC FOR REAL ESTATE

The steps for setting up a Self-Directed IRA LLC for real estate is the same as for establishing a Self-Directed IRA LLC for “any” investment. Here are the steps for setting up your real estate Self-Directed IRA LLC.

STEP 1: A Self-Directed IRA account is established with an IRS approved custodian.

STEP 2: Funds are then transferred from your current IRA or company 401k, 403b or profit-sharing plan to the Self-Directed IRA custodian” tax-free””

STEP 3: A Limited Liability Company (LLC) is formed with the IRA account owner designated as Manager and the IRA as owner (member) of the LLC. This includes having a legal document called an Operating Agreement drafted and obtaining an EIN.

STEP 4: At the direction of the IRA owner, the custodian invests the IRA funds into the newly formed IRA LLC. One or more IRAs can be used to fund the IRA, including Traditional, Roth, and SEP IRAs.

STEP 5: The Manager of the new IRA LLC (the IRA owner) directs all, or a portion, of the IRA funds held in the new LLC bank account for investment.

STEP 6: The LLC makes a real estate investment using IRA funds and all income and gains generally flow back to the LLC tax-free! The title to the investment property and all transactions documents should be in the name of the Self-Directed IRALLC

That’s it. While there will be variations on the above steps (e.g. if investors outside the IRA invest in the real estate, then the title to the property is split among all investors). IRA Village completes Step 3 for you and will assist and guide you with respect all the other steps.

LEGAL RULES THAT APPLY WHEN USING SELF-DIRECTED IRA LLC TO INVEST IN REAL ESTATE

There are a few legal rules you should be aware of when using your Self-Directed IRA LLC to invest in real estate. While the following list is not intended to be complete (you should consult a competent legal or tax advisor for guidance), some of the more important rules are listed below:

  • The deposit and purchase price for the real estate property should be paid using Self-Directed IRA LLC funds or funds from another investor who will have an ownership interest in the property.
  • All expense, repairs, taxes incurred in connection with the real estate should be paid using the Self-Directed LLC funds and not your personal funds (unless you have a direct ownership interest in the property).
  • If you as the account holder serve as manager of the LLC, you cannot receive any compensation or other benefit (other than the investment return to the IRA) from being manager.
  • As the owner of the Self-Directed IRA, you cannot invest in any property you own or property owned by a disqualified person.
  • As the owner of the Self-Directed IRA, you cannot benefit from the property in which the Self-Directed IRA LLC invests. For example you cannot live in the property or vacation in the property.
  • You cannot use recourse debt to purchase property that a Self-Directed IRA LLC invests. If debt is used, it must be non-recourse debt (see definition above).
  • Title to the property purchased should be in the name of the Self-Directed IRA LLC. For example, if the Self-Directed IRA owner names his or her LLC “Real Estate LLC”, title to the real estate purchased would be in the name “Real Estate LLC.

If you have any questions regarding whether a particular transaction would constitute a prohibited transaction please contact an attorney at our affiliated law office, IRATaxLawyers.com. Please use the “speak with an attorney” tab on our website to contact an attorney specialized in tax and IRA law.