History of the Real Estate IRA
To make
matters simple we are limiting our information to IRAs only. All
the information given and strategies discussed may be done with
any qualified retirement account.
The ability to
purchase real estate within an IRA or any other qualified
retirement account has been around since IRAs were first
enacted. Traditionally, the only investors able to utilize this
strategy were those that had substantial assets within their
retirement accounts, such as the affluent or pension plans from
large corporations.
Traditional lenders
were not willing to create mortgages for this type of strategy,
mostly because there were no clear cut rules as to how the
actual process works and the legal remedies that could be
imposed, if the loan were to go into default. Thus, the only way
investors were to capitalize on this strategy, was to purchase
real estate entirely with cash.
Currently, the IRS
does not have specific rules on which investments are permitted
in retirement accounts, however, they do have specific
requirements as to which investments are NOT permitted. A
qualified retirement account may not contain investments in
insurance policies, Sub Chapter S Corporations, or collectables
such as art works, rugs or antiques, metals or gems, stamps,
coins, and any alcoholic beverage.
Within the last few
years, there has been an increase in the knowledge and
popularity of purchasing real estate in a qualified retirement
account. This is due to the combination of the lackluster
performance and investor sentiment towards the stock market and
the emergence of court rulings and guidelines for real estate
lending to qualified retirement plans.
Now, the everyday
investor may utilize their IRA for the down payment on
investment real estate, granted that they follow the imposed
guidelines and that they hire the proper Custodians and
Administrators to handle these types of transactions.
At this time, there
are only a handful of IRA Custodians and Administrators that
have the expertise, knowledge, and processes in place to conduct
these types of transactions within current Federal guidelines.
Since real estate is
considered a non-traditional asset, the custodial and
administrative services needed to maintain them require careful
research, extensive paperwork, and additional IRS-reporting
methods. Therefore, traditional investment firms such as banks,
brokerage houses, trust companies, and credit unions are
unwilling to undertake the additional challenges. In other
words, there is not enough revenue generated to warrant the
additional administration needed for each client and their
individual transactions.
Additionally, these
custodians must be separately licensed by the Employee Plans
Division of the IRS and restrict their IRA clients to a limited
set of investments. Their specific structure or license may
restrict them from certain types of investments, or they may not
be organized to profit from any investment other than their own
proprietary investments (i.e. mutual fund companies).
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Real Estate
IRA Structure
There are two ways that
an investor can use their IRA to purchase investment real estate and
it truly depends on the investment objectives and time horizon of
the IRA and its owner.
Direct Investment
through the IRA
An investor may use
their IRA, directly, to purchase investment real estate either
outright (complete purchase price) or as a down payment and carry a
mortgage for the remaining amount.
An investor may choose
to use their IRA as a down payment and mortgage the remaining
amount. However, the IRS and the Employee Retirement Income Security
Act (ERISA) have restricted the
type of loan to a “non-recourse” loan. Essentially, a non-recourse
loan is one that the IRA owner may not personally guarantee the
mortgage. Should the property go into default, the lender may not
look to the IRA or IRA owner for additional funds. The lender can
only repossess the property.
Typically, the loan
terms of a “non-recourse” type of loan are not the most conducive to
investors. Currently, the down payment terms are restricted to a
minimum of 30-35% and the only payment program offered is a
principal and interest loan that is fixed for the first 5 years and
than becomes variable.
Advantages
Disadvantages
-
Limited number of
traditional lenders available
-
Need for larger down
payment
-
Lack of investor
friendly mortgage terms
-
Increased/variable
custodian fees
-
Limited allowance of
real estate investments (i.e. rehab, pre-construction)
-
Lower investment
returns
Passive Investment
through a Limited Liability Company
An investor may use
their IRA to purchase a majority interest in a Limited Liability
Company (LLC) that primarily invests in real estate and thus pass on
income and appreciation as dividends or distributions. This option
does carry some additional administrative rules and governance, but
can be offset by the favorable lending terms and the increased
return on investment.
According to Federal
guidelines, if an IRA purchases an interest in an LLC, the IRA and
its owner (in combination) must own less than 100% of the available
shares. In other words, an IRA cannot be the only member of an LLC,
there must be at least one other individual or entity. This
individual or entity may not be a “disqualified person” (discussed
in Real Estate IRA Basic Rules section).
The loans available
under this arrangement are more favorable than if the IRA were to
secure the mortgage itself. Typically, a traditional lender will
require a minimum down payment of 20-25% and the payment programs
can range from a traditional 30 year fixed to an interest only
payment. The lender is able to offer these terms because the IRA
owner is allowed to personally guarantee the mortgage, thus
alleviating a lot of the default risk.
Advantages
-
Unlimited investment
choices
-
Greater number of
available mortgage lenders
-
Smaller down payment
requirements
-
Greater number of
investor friendly mortgage terms
-
Unlimited allowance
of real estate transactions (i.e. rehab, pre-construction)
-
Lower/fixed
custodian fees
-
Higher investment
returns
Disadvantages
-
Need for additional
partners or investors
-
Additional annual
administrative costs
-
Increased challenge
in adding dollars to investment objectives
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Real Estate IRA Basic Rules
Real estate transactions within an IRA must be completed within
certain IRS and ERISA guidelines. Real Estate must be purchased for
investment purposes only and must be in accordance with the
following:
-
A qualified plan may not, directly or indirectly, sell,
exchange, or lease any property with its owner or “disqualified
person”. This includes lending money, extending credit,
furnishing goods, services, or facilities.
-
A qualified plan, qualified plan owner, and disqualified person
may not, directly or indirectly, own 100 percent of the shares
of a limited liability company (in combination).
A “disqualified person” includes the following persons and entities:
-
Qualified plan owner;
-
Ascending and descending family
members, including spouses, of the qualified plan owner (not
including siblings);
-
A fiduciary;
-
Persons providing services to the
qualified plan;
-
A corporation, partnership, trust,
or estate of which (in which) 50 percent or more of the combines
voting power of all classes of stock entitled to vote or the
total value of shares of all classes of stock of such
corporation, the capital interest or profits interest of such
partnership, or the beneficial interest of such trust or estate,
is owned directly, or held by such persons described above;
-
An officer, director, (or an
individual having powers or responsibilities similar to those of
officers or directors), a 10 percent or more shareholder, or
highly compensated employee (earning 10% or more of the yearly
wages of an employer), a 10 percent or more (in capital or
profits) partner or joint venture of a person.
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What We Offer
Independent Executive Management, LLC offers complete administration
for an investor’s Real estate IRA. Our administration includes:
-
Selection of a
Self-Directed IRA Custodian that best fits the investment
objectives of the client. We make sure that the IRA Custodian
selected for each client is the most appropriate custodian for
the client’s specific investment transactions. Failure to
properly select a custodian may result in higher fees and
transaction costs as well as the inability to purchase certain
investments;
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Proper structuring of transactions and assets in IRAs and
Qualified Plans to remain in accordance with Federal guidelines.
This helps to avoid possible prohibited transaction problems,
and helps clients accomplish their investment goals;
-
Creative solutions to difficult problems. We work closely with
clients to arrive at solutions that consider both the immediate
effect of a transaction, and the potential risks of a
transaction being carried out in contravention to the IRS
Indirect Rule. In providing such guidance, we help insure that
client accounts are safeguarded from disqualification;
-
Review and execution of new and pending transactions. We make
sure that each transaction and the annual maintenance of the
assets are held in compliance with current IRS and ERISA
guidelines;
-
Annual bookkeeping and administrative services for each Limited
Liability Company. We handle all the annual reporting and
management required by State and Federal Legislature in the
operation of a Limited Liability Company. This allows for the
client to relieve them self from the everyday “hands on” tasks
often associated with real estate.
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