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Self-Directed IRA – FAQs

 

 

How long has this investment option been available for IRA’s?

The fact is that you have been able to buy real estate with an IRA since the first day IRAs were created in 1975.  The IRS regulations only define what you cannot invest in with an IRA (life insurance contracts, collectibles and capital stock of “S” corporations) not what you can. (See IRS Publication 590 at www.irs.gov).

Why has my broker, financial planner or banker not mentioned this option to me?

Stockbrokers, mutual fund managers and bankers are only interested in selling you stocks, bonds, mutual fund shares or certificates of deposit for your IRA portfolio. Their commission income is dependent on the extent that you are invested in their products. As investors have become more disillusioned and frustrated with traditional equity investment choices they have turned to investing in the real estate alternatives. Many IRA investors, seeing their retirement accounts subject to the on-going stock market roller coaster, are taking control of their own IRA investments.  However, when they ask their current custodian/broker/financial planner/banker, they are typically told that such investments are “illegal”, too complicated or that it simply cannot be done. Although those custodians/brokers/financial planners/bankers may not allow it, it can be done. It is quite likely you cannot do it through your current custodian because they will financially suffer if you make such a move. Therefore to protect their income stream, they will not to tell you about it.

What types of real estate property can I invest in?

Typically the types of real estate properties that are assets in a real estate IRA are:
•    Single family and multi-unit homes
•    Apartment buildings
•    Co-ops
•    Condominiums
•    Commercial property
•    Improved or unimproved land

What types of retirement accounts can be moved into Self-Directed IRA accounts?

Traditional IRAs, SEP-IRAs, Roth IRAs, 401Ks, 403Bs, Coverdell Education Savings (ESA), Qualified Annuities, Profit Sharing Plans, Money Purchase Plans, Government Eligible Deferred Compensation Plans, and Keoghs.

I have several IRAs and old 401Ks. Can I combine them?

Yes. The can all be combined into your self-directed IRA and the total amount be invested in real estate. The only restriction is on 401Ks; at is that you generally must no longer work for the employer.

Can my IRA purchase real estate that I own presently?

No. This is considered a prohibited transaction. You may not purchase a property or interest in a property, which is presently owned by a disqualified person. Disqualified persons would include you, family members of linear descent and entities you control.

Can my IRA purchase real estate that my corporation, partnership, or LLC owns?

If your ownership is 50% or greater in the entity that currently owes the real estate property, the answer is no. See previous question.

What are Prohibited Transactions?

Understanding what constitutes a prohibited transaction is very important when it comes to making investments within your IRA. The IRS defines a prohibited transaction as follows:  Generally a prohibited transaction is any improper use of your IRA account or annuity by you, your beneficiary or any disqualified person. Disqualified persons include your fiduciary and members or your family (spouse, ancestor, linear descendant, and any spouse of linear descendant). (See IRS Publication 590 at www.irs.gov). Internal Revenue Code Section 4975 is the section that lays out the rules on prohibited transactions. Prohibited transactions generally involve one of the following:

  1. Doing business with a disqualified person.
  2. Your IRA must not engage in transactions that benefit you personally.
  3. Loaning money to a disqualified person; or
  4. Investing in a prohibited investment

 

In plain English, prohibited transactions are those transactions that violate the basic intent of the IRA. Your IRA must benefit rather than benefiting you personally. In other words, there can be no “self dealing” transactions. However, there are many ways in which you can invest your IRA and not be in violation of the prohibited transaction law. And when your IRA benefits, you benefit because it is for your retirement.

Can my IRA invest in a newly formed entity that will invest in real estate?

Yes. Investments in newly formed private entities are not prohibited under the IRC, with the exception of Subchapter S corporations, provided the new entity is funded simultaneously from IRA and non-IRA sources. In fact, my recommended method of ownership of real estate assets by an IRA is to utilize a limited liability company (LLC) as the entity that actually owns the real estate assets.  Your IRA would own a majority share of the LLC and you would personally own a minority share.  If such an arrangement is properly structured, the advantages are many:  ease of management, local control of revenues generated and expenses paid, the allowable usage of loan/mortgage funding to lever your investment and usage of in-kind distributions (increase of LLC ownership interest to accomplish Required Minimum Distributions (RMDs) of a non-monetary asset.

Can I buy my dream retirement home or dream lot with my Self-Directed IRA and then live in it or build on it when I reach the age of retirement?

Yes.  Utilizing the ownership method from the previous question, the limited liability company (LLC) would actually own the real estate asset; your IRA would own a majority share of the LLC and you would personally own the remaining minority share.  Using planned program of in-kind distributions of the LLC ownership interest over a number of years to spread out the taxable income, ownership would be transferred from the IRA to you personally allowing you to build upon or move into upon reaching your desired retirement age.