You Can Buy Real Estate in Your IRA, 401k or Other Qualified Retirement Plan
You Can Buy Real Estate in Your IRA, 401k or Other Qualified Retirement Plan
You Can Buy Real Estate in Your IRA, 401(k) or
Other Qualified Retirement Plan
When Congress created the Employee Retirement Income Security Act of 1974 (ERISA) in 1974, launching tax-sheltered individual retirement accounts (IRAs), they did not write the law to favor stocks. Wall Street, however, recognized a good thing when it saw one and it rushed to tell America that all their retirement money should be in mutual funds.
Your IRA can be a self-directed retirement plan. That means you can buy businesses with your retirement funds, lend money, and do many other things to provide for your retirement that have nothing to do with stocks.
Chief among these is the ability to buy real estate through your IRA. And that means you can get higher returns and lower risk than you get from stocks—as long as you follow the principles we've been hammering home in MSM.
How much higher?
Well, stocks have returned about 10% a year over the last 100 years. Not bad. But even if you're just a fair to middlin' investor—and even if you don't use a lot of leverage—you should be able to compound your investments over the long term in the 15% range easily.
For instance, a $100,000 property that appreciates at the long-term average of 6% a year doubles in value after 12 years. If you put $25,000 down to buy it and borrowed the rest at 7%, your $75,000 mortgage has amortized to about $60,000 in that time. So your equity has mushroomed from $25,000 to $140,000 ($200,000 market value minus $60,000 outstanding mortgage).
That's a little better than a 15% compounded average annual return—without a great deal of leverage and getting appreciation in the range of the long-term historical average.
But if you buy a little better, you'll do substantially better. If you buy under market and in an area that is rapidly appreciating, you might end up averaging 8% compounded returns per year. This would make the property worth double your purchase price in nine years.
And that doesn't even include steadily increasing net rents… which could push your compounded average annual returns up another few percent.
So why is your IRA, 401(k) or other qualified retirement plan stuffed to the gills only with stocks or mutual funds? And in many cases with stocks and mutual funds that are below their prices of five or six years ago when you first bought them?
It's Perfectly Legal to Buy Real Estate in Your IRA
sitting right in your IRA, 401(k) or other retirement plan.
Qualified Pension Plan. And your IRA can borrow to help you make that purchase.
investments. In some cases they have been told it makes no sense. In the meantime those in the
So Why Should You Overlook the Opportunity?
do as it relates to investing your IRA. IRC 590 specifically details what are called "prohibited
(unless you're an accountant). It is long, convoluted and often contradictory. Even most experts
tell you what you cannot do and not to tell you what you can do. Fortunately for us, it's very clear
from the code—and from precedent—that you can legally purchase real estate.
Wall Street's Misappropriation of the IRA
history of IRAs.
and investing for their own future retirement. There have been many changes to these rules over
best obscured and at worst lost. That is the whole concept of Self Direction.
create commissions for themselves by providing IRA accounts for eligible investors. What they
when you look at the rules that govern what you can and cannot own (IRS 590) you will be
Wall Street's Wall of Silence
stocks and bonds? Very simply it's all about the money.
A significant number of investors have their IRA funds with custodians who also happen to be in the business of "providing" investments or investment advice. So even though most investors have a self directed IRA they end up with custodians who put restrictions on what they can and cannot invest in.
These custodians have chosen to do this for their own financial benefit and not the benefit of the underlying IRA participant. If you are using one of the major Wall Street firms, they are in the business of selling you investments on which they make commissions or fees, things like stocks, bonds, and mutual funds.
I am not saying you should not own these investments, But these shouldn't be the only investments you own in your IRA—especially if you're a knowledgeable real estate investor.
What's more, there are times when the market offers horrendous value and has lousy prospects (as from 2000 through 2002), so it's nice to have alternatives. And real estate is traditionally not correlated to the stock market.
From Wall Street's Control:
There are a number of custodians out there who will allow you to purchase real estate. They are far and few between but they are out there. The good ones have been doing it for a long time, have this process down to a science and know exactly what it takes to make it happen in a legal and compliant fashion.
qualify-tax-deductible contributions. It doesn't say or imply in any way that you can only buy mutual funds."
Certainly, they charge their own fees for this service. But they do not tell you what you can and cannot do with your money; beyond ensuring what you are doing is permissible. (More about that later.) These types of custodians are not in the business of selling you investments. They make their money from the fees they charge to act as the custodian and/or administrator of your account.
Kind of Real Estate
That's right, you can even buy foreign real estate through your IRA! Maybe you have found a little piece of beachfront property in Mexico you would like to build on for your future retirement home. You can legally do this through your IRA.
In fact, your IRA can even purchase an option on any of these types of properties. It can also makeother real estate related investments. For instance,you can buy mortgages or other notes through your IRA. You can buy tax lien certificates and defaulted notes.
For the purposes of this lesson, however, we're going to stick with real property.
So You Can Make the Most Out of What You Can
There are some restrictions on any investment you make with your IRA. These restrictions apply to real estate investments as well. One of the primary restrictions is this regard is that any investments your IRA makes cannot be for your benefit today. They must be for the future benefit of you, your heirs or both. This means if you purchase real estate in your IRA, you cannot use it in any fashion until you retire… well almost any fashion.
Say you buy a beachfront property as an investment through your IRA. You rent it out most of the time and perhaps you're anticipating retiring to it one day. But you may also want to use it occasionally now. There are certain circumstances by which you can do just that.
The code is actually a little more flexible than you might think. It allows your friends and some of your relatives to use your property prior to retirement. So even though you are specifically prohibited from using your property, many of your relatives are allowed to use it. And anyone not related to you is allowed.
Who is a "related" party that would be prohibited from using the property? The IRS Publication
However, if your property is repeatedly and only used by friends and relatives who always invite
you as their guest and never pay any rent to use the property, the IRS would infer you really used it for your own benefit. So some common sense is warranted.
When it comes to the use of the property, it is an honor system. Your IRA administrator or custodian is not going to keep track of who uses your property. And the IRS certainly does not have the manpower to keep track. So it is very unlikely that anyone is going to be checking up on you. It is up to you to abide by the rules.
"Your IRA can even purchase an
option on properties. It can also
make other, non-physical, real
estate related investments. For
instance, you can buy mortgages or
other notes through your IRA. You
can buy tax lien certificates and
One of my favorite examples is a group of doctors whose retirement plans own the land and the building out of which their medical clinic operates. In another case, an individual was able to purchase 176 acres of unimproved land from his own IRA and then use that land for himself, personally.
These fall squarely into the list of prohibited transactions. They cannot even be called a gray area. So how did they get away with it? It turns out the Department of Labor has granted a number of blanket exemptions to the prohibited transaction rules. And as long as you follow their exemption application procedures and meet their criteria, you can receive approval for a similar transaction under one of these blanket exemptions.
The subject of exemptions is highly complex and technical. So if you want more information on this subject, go directly to the DOL's web site, where they list these blanket exemptions and have all of the necessary information required to apply for your own exemption.
The general website is http://www.dol.gov/. A specific link for this section is http://www.efast.dol.gov/You can also contact Ekaterina A. Uzlyan of the Department of Labor at (202) 219-8883.
Turning Your IRA into a Real Estate Investment
In describing the different possibilities and flexible nature of your IRA, I've gotten a little ahead of myself. So let's get back to basics and talk about how this all works, step by step.
Chances are your IRA or retirement plan is not currently with a custodian who is going to allow you to buy real estate through it. So your first step is to find a custodian that allows for truly selfdirected IRAs. The simplest way to do this is to do an Internet search for "self-directed" IRAs and check out their websites or call them to find out if they handle real estate purchases for the IRAs they administer.
Your custodian will take care of all closing documents and the property will actually be purchased in the name of your IRA or retirement plan.
The Nitty Gritty
"the Department of Labor has granted a number of blanket exemptions to the prohibited transaction rules."
Some of the common questions that arise concerning buying real estate through your IRA are…
Can my retirement plan borrow part of the money?
In normal real estate transactions, you can buy properties individually in personal name, with partners or as a business entity. This same flexibility applies to owning real estate in your retirement plan.
For instance, property owned by a retirement plan can be owned partially or fully by the plan. This opens up a universe of opportunities.
Let's say you have found a piece of property you are interested in purchasing but you do not have enough money to buy it outright with either personal or retirement assets. You can legally own it with both and in any fractional combination.
In fact you can own property with your IRA with as many other entities as you want. There are virtually no restrictions. However, if you own property fractionally with your retirement plan, all income and expenses must also be accounted for fractionally.
Let's look at a couple of simple examples.
You purchase a piece of property for $200,000. To keep it simple, let's ignore leverage for the moment and assume you purchase it for 100% cash. You pay for half of it with personal assets and half with assets from your IRA.
Your custodian will now ensure when the transaction closes that you own it 50% personally and 50% by your IRA. Going forward, you must pay for any expenses or improvements in the property in the same manner, 50% personally and 50% with your retirement plan. So if you need to put a new roof on your rental home for $15,000. $7,500 must come from your IRA and the other $7,500 from personal assets.
Similarly, if it is income-producing property, the same principle applies to the income it generates. Half would be earned by you, and hence half would be taxable. The other half would be earnedby your retirement plan and be tax-deferred (if in a traditional IRA) or tax-free (if in a Roth IRA).
There is virtually no limit on the numbers of partners with whom you can own the property. And your partners can use personal assets or retirement assets for their investment funds too.
And Title It in a Business Entity
For privacy or asset-protection purposes, you may prefer to own your properties in a corporate entity such as a Limited Liability Company. Your IRA or retirement plan can also own property in this manner, with some minor exceptions.
Once again the IRS wants to make sure you use your retirement plan as an investment for the future and not for today. So they make it clear you cannot enter into any transaction that might be considered self-dealing. And most custodians want to ensure you do not accidentally or purposefully enter into a transaction that might trigger any self-dealing. So most of them put some minor restrictions on the form of corporate ownership you can be involved in.
You can establish a new corporation that would be 100% owned by your IRA. However, if you want to own the corporation personally (rather than own the corporation through your IRA), mostcustodians will only allow you to own it with up to a 49% share. The remaining 51% must be owned by an unrelated party.
You Can Use Leverage in Your IRA
One of the most common questions that arises is how do I pay for the property? More specifically, can my retirement plan take out a mortgage? The answer is yes!
Many lending institutions simply will not loan money under these conditions. Others may only grant loans up to 70% or 75% of the purchase price, requiring a 25% or 30% down payment from your IRA. Other, non traditional lenders, however, may be willing to make a higher loan-to-purchase-price to your IRA— if you've bought it at a good enough price that the loan to appraised value is low enough.
So let's say you've bought a property in preforeclosure for $100,000, and the property has a market value of $130,000. Even though you have all that extra equity in the property from buying below market, a traditional bank may only be willing to lend your IRA 70% or so of your purchase price… or $70,000 in this case. However, a non-traditional lender may be willing to lend you 70% of the appraised value ($130,000 in this example). That would mean you'd get a loan of $91,000 for this purchase, instead of the $70,000 offered by the bank.
"You can establish a new
corporation that would be
100% owned by your IRA.
And you can then own
investment property in that
The Key Steps of Buying Real Estate through Your Ira
Find a custodian for truly self-directed IRAs Arrange for transfer of funds Fill out "buy direction" letter Execute sales contract with help of administrator Apply for loan in the name of the IRA Close on transaction and reap taxsheltered benefits Option to pay yourself an asset management fee (not a direct property management fee)
It is also important to note when you have debt-financed real estate in a retirement plan the mortgage payments must come from either income from the property, existing plan assets, new contributions to the plan, or some combination of these. But you've already learned in MSM to make sure all your rental properties pay for themselves and that you always should have a margin of safety. So if you follow those guidelines, your carryingcosts should all be covered by the property itself. And this requirement won't be difficult to meet.
When Your IRA Borrows to Buy Real Estate
The Pros and Cons of Using Your IRA to Buy Real Estate
Some commentators say it is not a good idea to buy real estate with your retirement plan while others have whole-heartedly embraced the idea. Like anything, there are pro's and con's. Among the key positives…
More Info on Buying Real Estate
through Your IRA
For More Information on Self-directed IRAs,
go to the IRS website (http://www.irs.gov/)
and select publication 590.
You can also contact Larry Grossman
directly, at Sovereign International Asset
Management, Inc., 1314 Alt 19, Palm
Harbor, FL 34683.
Tel. 877-733-6815 or 727-286-6237
In my opinion, owning real estate in a retirement plan makes a great deal of sense. The investors I have assisted have been thrilled to be able to invest in a number of different types of projects and finally put their retirement assets to work in an investment they know and understand. And I believe many more investors would welcome the opportunity if they only knew the option exists.
Now, you are one of those in the know. So let's take a look at a few deals we have been able to put together for our clients… so you can get an idea of how using your IRA to buy real estate might help you.
Doc Tim Buys His Future Retirement Haven
Tim is now the happy owner of 3 lots on the side of a beautiful mountain in NC. Currently, these lots are in the form of unimproved raw land. Tim is free to hold these purely for speculation or to build on these lots using other retirement assets.
A Seasoned Real Estate Investor Taps into Her IRA Funds
Barbara A from Olympia WA has been speculating in real estate for years. She was tired of not earning the kinds of returns in her IRA she had become accustomed to earn as a real estate investor. Barbara contacted our office when she heard about our ability to purchase real estate in a retirement plan.
Case Study # 3:
Developing Caribbean Real Estate through an IRA
"I'm Developing Caribbean Real Estate with My IRA Funds. I read one of Larry Grossman's articles about using IRA funds to purchase real estate overseas and called his group for more information. Soon, I embarked on an adventure to purchase and develop some ocean front property on a Caribbean island.
"Larry and his group worked to get the funds consolidated from 20 individual accounts to fund the adventure. They helped establish new IRA and non-IRA accounts with a new custodian. They also set up a corporation, and transferred the funds on an accelerated schedule.
"We have now purchased the land; we have building permits and environmental impact statements approved. Our comprehensive Master Plan for single-family homes, condominiums, apartments, and commercial and office space is exciting. The survey is finished; the lots are staked out and go on sale in a week. We have Letters of Intent onsix lots. The promotional materials will be done within two weeks and the roads and utilities will be in within 90 days."
Case 4 is a hypothetical case to show just how diverse a transaction like this can actually be.
Case Study # 4:
A Hypothetical Case: This Could Be You
Jim was tired of losing money in the market and knew there had to be a better way to do things. Jim lives in Boston, which has been a hot real estate market and he thought it was only going to get hotter. Jim had his eye on a new office complex he drove by everyday on his way to work. He had checked into the property and knew there was a shortage of good office buildings like that in the area.
The problem was the developer wanted $1,000,000 for the property. Jim has a million dollars; he has done well over the years. But he did not have a million in either his personal accounts or his retirement accounts. But he did have a million between them all combined.
The property is actually owned and titled in the name of all 3 entities. Jim therefore keeps track of all expenses and income and prorates this to all three entities in the same percentages as it is currently owned.
That Can Invest in Real Estate
Virtually any individual retirement plan is eligible to invest in
What's more, the rules governing these types of investments are basically identical for all types of plans. The key is to work with a knowledgeable team of advisors or a custodian who understands truly self-directed plans and will allow you to make these types of investments.
Until next time, invest well.
For Main Street Millionaire
IRA Transfer-rollover PDF
Buy-Direction Letter PDF