Safe Investment – Self Directed IRA Real Estate Rules

For most IRAs you can only hold approved investments. Namely mutual funds, ETFs, stocks, CDs and bonds. If you want to purchase alternative investments like private placements, tax liens and real estate you need to do that with a self-directed IRA (SDIRA). The tax shelter that the SDIRA provides is the ideal way to invest in real estate. In fact, it is the most popular alternative investment held in IRAs in America.

What is a Self-Directed IRA?

A Self-Directed Individual Retirement Account is a special type of IRA that allows you to hold alternative investments like tax liens, private placements, precious metals and especially real estate. The companies that offer SDIRAs are called custodians and although they administer the accounts it is you, the account holder, that directly manages the IRA.

This means that you make the investment decisions (the custodians are not allowed to give advice) and manage all the risks. Usually these types of accounts are suitable only for experienced sophisticated investors and there are certain rules that must be followed.

It may also be advisable to set up a limited liability company (LLC) in order to hold the investment assets. You should talk with a taxation professional to determine which options are best suited to your particular situation.

Rules for SDIRAs: There are many benefits to holding real estate in your SDIRA but they all go away if you don’t follow the rules.

1. Your SDIRA is not allowed to purchase real estate that is owned by you or by any disqualified person. The IRS considers this to be “self-dealing” and it is a no-no. A disqualified person is:

• You,
• Your beneficiary,
• Your spouse,
• Your parents, grand-parents or great grand-parents,
• Your children, your grandchildren or great-grandchildren and their spouses,
• The service providers of your IRA,
• Any entity (corporation, estate, partnership, etc) in which you own 50% or more of the voting stock.

2. Indirect benefits are disallowed. You cannot indirectly benefit from a property that is owned by your SDIRA. For example, you cannot use the property as your office or rent it out to your daughter or other family member. You cannot use it as a vacation home or cottage. The whole point of the Individual Retirement Account is to provide for your retirement at some future date. It is not intended that you (or any disqualified person) benefit from it in the present.

3. Your investments must be uniquely titled. This means that your IRA must be a separate entity from you. Any real estate that is held by the IRA is owned by the IRA and NOT by you.

4. You may buy real estate in partnership with other funds. This is a great way to claim ownership of a larger real estate deal than you could afford on your own. However much you invest in the deal on a percentage basis is how you determine how to pay expenses and how much to receive in income. Keeping in mind that all transactions must go through the SDIRA.

5. If you use financing you may trigger unrelated business taxable income (UBTI). Taking out a mortgage to pay for the real estate is what most people do when buying a home. But your IRA should probably not do this since it will trigger up to 37% tax rate on the income earned. Which kind of negates the whole point of buying real estate inside of your IRA.

6. All expenses related to the property must be paid from the IRA and not from your personal account. This includes all maintenance, improvements, property taxes, fees, bills, etc. For this reason, you must be sure that you have sufficient funds in your SDIRA to cover all expected costs plus a little extra for those un-expected costs.

7. Any income generated must flow through to the IRA. Naturally the rent your tenants pay must be paid out to your SDIRA and not to you personally.

8. All the regular IRA rules also apply. Your self-directed IRA can be traditional or Roth and you may own multiple IRAs but the contribution limits (see below) are applied to cover all of them collectively. Briefly here are the rules around Individual Retirement Accounts.

Traditional:

• All contributions that you make are considered tax deductible. This means that it reduces your taxable income and may potentially put you in a lower tax bracket.
• Maximum contributions for 2020 is $6,000. If you are over age 50 the maximum is $7,000. Your contributions must come from earned income as defined by the IRS.
• All your investments within the IRA will grow tax free until you make a withdrawal. This can really boost your returns and allow your nest egg to get bigger faster which will ultimately allow you to become involved in larger real estate deals and earn more profits.
• Your withdrawals will be taxed as though it were regular income. Ideally you will only be making withdrawals upon retirement and you may be in a lower tax bracket at this time than at the time those investment profits were actually created.
• You will pay a penalty for early withdrawal (before age 59 ½ years of age).
• You will be required to make minimum withdrawals by the time you reach age 72. This can be complicated when your assets are real estate, as it may be difficult to sell in a hurry. As you approach age 72 it is a good idea to review your holdings and potentially sell some or all of your property so that you can comply with this minimum withdrawal rule.

Roth:

• Your contributions are made with after tax dollars. Therefore, there is no tax deduction that you can take. However, it means that any withdrawals are tax free.
• Maximum contributions for 2020 is $6,000. If you are over age 50 the maximum is $7,000. Your contributions must come from earned income as defined by the IRS.
• There is an income limit that restricts high income earners from opening a Roth IRA. These limits are based upon your modified adjusted gross income and your tax filing status. If you are single and in 2020 earn less than $124,000 per year you can contribute the maximum amount. If you earn more than $139,000 then you ineligible for a Roth IRA. (Between those amounts there is a phased amount you can contribute). If you are married and in 2020 earn less than$196,000 filing jointly then you can also contribute the maximum amount. More than $206,000 and the married couple is ineligible.
• You cannot contribute more than your earned income.
• There are no minimum required withdrawals at any age.
• You may be subject to a 10% tax on withdrawals before age 59 ½ .
• You may withdraw earnings without penalty if you have owned the account for at least 5 years and are over the age of 59 ½ .

Conclusion: Self-directed IRAs allow for the purchase of real estate. So long as you follow all the rules and regulations it can be a great way to grow your account for your golden years. Because your earnings will grow tax-free it can accumulate faster and allow you to build your real estate empire.