SELF-DIRECTED REAL ESTATE IRA

While some self-directed IRA trust custodians restrict your investment options, others allow you to take advantage of the full range of IRS-permitted assets. Listed below are just some of the special asset types that self-directed IRAs can often accommodate:

• Real estate Including single or multi-family dwellings, apartments, commercial buildings, raw land, vacation property, condominiums, mobile homes, etc.
• Trust Deeds / Mortgages, and Mortgage Pools
• Private Notes and Loans
• Private Stock Offerings
• Limited Liability Corporations (LLCs)
• Limited Partnerships (LPs)
• Tax Certificates
• Receivables
• Stocks, Bonds, Mutual Funds
• Annuities
• Commercial Paper
• Unit Trusts

ABOUT REAL ESTATE INVESTING WITH YOUR SELF-DIRECTED IRAs

The Basics

The rules governing allowable investments in IRAs preclude an IRA's investment in life insurance, collectibles (e.g., artwork, antiques, metals, gems, and most coins) and S corporations.

All other types of investments are permitted, and thus the range of possible investment choices is nearly unlimited. Consequently, any form of real estate can be purchased by an IRA.

Real estate investing through an IRA opens up a huge range of alternative investments for individuals who are knowledgeable about real estate investing or who work with knowledgeable advisors, sponsors, or brokers. Investing in real estate for your retirement may serve as a means to diversify your retirement portfolio to hedge against the cyclical changes in the stock market, economy and bank and government-based investments.

For many who are experienced with real estate investing, real estate investments hold the potential to protect against the loss of principal while generating better than market rate returns through income production and capital gains. When real estate investments are not leveraged, both income and capital gains can flow back to IRAs tax-deferred (or tax-free if the IRA is a Roth IRA).

Easy

If you have your IRA purchase real estate from an unrelated party and pay cash for it, and you do not use the real estate for personal reasons while it is in your IRA (i.e., you treat it strictly as an investment), there are no special issues.

More Difficult

If your self-directed IRA invests in real estate through a down payment and leveraging, there are some significant issues:

1. You cannot personally guarantee a loan for your IRA;
2. Some custodians will limit the amount of debt the IRA can carry (Most administrators limit is 50%);
3. It may be difficult to get a bank to allow an IRA to be the debtor without a personal guarantee;
4. Your IRA will pay tax on UDFI (unrelated debt financed income), which is the income and/or capital gains attributable to the leveraged portion. (UDFI is taxed at the trust tax rate because an IRA is a trust.)

As a consequence, although it is PERFECTLY LEGAL, it may not be desirable to have an IRA carry debt in a real estate investment transaction.

What you can not do in a Self-Directed IRA with real estate

1. You cannot directly or indirectly buy real estate from a "disqualified person". Who is a disqualified person?

• The IRA owner;
• the IRA owner's spouse, descendant (e.g., son), or ascendant (e.g., mother);
• spouse of a descendant of the IRA holder;
• a fiduciary of the IRA or person providing services to the IRA (e.g., the trustee or custodian);
• an entity at least 50% of which is owned (or at least 50% of the beneficial interests are held) by a combination of the above (e.g., if you and your spouse own 50% of an LLC, that LLC is a disqualified person with respect to your IRA); or
• A 10% owner, officer, or director or highly compensated employee of such an entity.
  

2. You cannot have your IRA enable an investment for yourself or another disqualified person. In other words, if the IRA's investment is deemed essential to accomplishing a transaction in which both you and your IRA invest, then the transaction would be considered a prohibited transaction.

3. Your IRA cannot purchase a real estate asset and then have a disqualified person use it while it is in the IRA. For example, you cannot buy a vacation home and use it partly for personal use, even though you might rent it to unrelated persons the rest of the year.

What you can do in an IRA with real estate

Buying real estate from an unrelated party (i.e., one who is not a disqualified person) with cash is the simplest way of investing in real estate with your IRA. Your IRA can buy raw land, commercial property, residential (e.g., rental) property, real estate options, as well as extend loans (e.g., first and second mortgages), secured by real estate with your IRA, to unrelated parties.

As discussed above, your IRA can also buy property through leveraging, provided the loan is not guaranteed by the IRA owner (or any other disqualified person) and that the IRA has enough liquidity to support the mortgage and expenses. Generally, most custodians will have limits on the amount of leverage they will permit. Also, as previously mentioned, leveraging can result in income taxes on UDFI that must be paid by the IRA. Generally, these taxes are higher than would be paid on income generated from a property that you buy and finance personally. In addition, the UDFI taxes must be paid from funds from the IRA and, therefore, there has to be enough liquidity in the IRA to cover these taxes. See IRS Form 990T and its accompanying instructions for details.

There are a variety of ways, however, that an IRA can participate in a real estate investment without a full cash capital investment. For example, your IRA can co-invest with other parties. You could also have your IRA, and other parties participate in real estate investing by becoming members of an LLC that buys and sells property.

Conclusion

In summary, the tax laws (1) require that the investments in an IRA not benefit the IRA owner and (2) prevent "self-dealing" between the IRA and the IRA owner or other disqualified persons. However, by properly structuring an IRA investment in real estate, an IRA can obtain the benefits of real estate investment in a manner that complies with applicable tax laws.

(The foregoing is a general discussion. It is not intended, and should not be relied upon, as an opinion or advice on any legal, tax or investment aspects of IRAs. An IRA owner considering an IRA investment in real property should consult with your own advisor.)