Using Retirement Plan Money to Buy Real Estate
Pacific Beach Real Estate, Mission Beach Real Estate, San Diego County Real Estate
I would like a dollar for every time I have been asked "can I purchase real estate with retirement plan money---IRAs, SIMPLEs, KEOUGHs, 529s, SEPs, 401ks, etc?"
In fact, not long ago, a couple approached me and proceeded to ask several good questions about San Diego real estate investing. They mentioned that they had $200,000 in a retirement account and when I congratulated them they said, "don't be impressed, we had $300,000 a few years ago!" Come to find out, their retirement account, like many others, had suffered as a result of investment choices. They went on to tell me that they had wished they had bought real estate instead of "investing in an IRA."
Like so many others, this couple believed that they were limited to investment in the more traditional forms of retirement investing...CDs, mutual funds, stocks and bonds, etc. So, they were amazed when I told them that they could have their cake and eat it too - or rather, have retirement plan money and real estate too! Let me explain.
First and foremost, a retirement account (traditional IRA, Roth IRA, SIMPLE IRA, SEP, Keogh, 401k, etc.) is not an investment! It's simply a special account that holds your investments. It can hold many types of investments, such as mutual funds, stocks, bonds, and...drum roll, please... real estate.
Picture a truck with the words MY RETIREMENT ACCOUNT
painted on the doors. In the back of the truck, you load whichever allowable investments you choose. As you picture this, ask yourself, "is my retirement truck on the way to becoming a big, heavy-duty monster truck or will I end up with a little, wimpy mini pickup?"
When I told this couple that their retirement account could own real estate they said, "but I asked the company that administers my account if my retirement plan assets could own real estate, and they said 'no.'"
Whoa! Instead of merely saying "no," the person they spoke with should have added three important words: "not with us."
Here´s the problem. Most companies that hold retirement accounts aren't geared up to handle real estate. Therefore, they have no incentive to inform their customers that real estate is a viable investment choice. That's the main reason for the misconception that real estate can't be held in a retirement account.
Let's get this straight. Retirement accounts CAN own real estate
In a minute, we'll get to the basic ins and outs of retirement plans owning real estate. However, I need to first note that this article is designed to be a launching pad for my clients and friends to begin their exploration of owning real estate with retirement money. While not "brain surgery", this can be a complicated subject and everyone's situation is unique. So, be certain to talk with your competent advisors before you take any action. OK, here we go.
First, you need to establish a self-directed retirement account with a company/custodian that specializes in real estate lRAs. (Note: For simplicity, I will use the term "IRA" as an all-encompassing term which also applies to other retirement plan money). This is a relatively easy process and can be done by either establishing a new account or rolling over the assets of an existing account. Item of caution: Be sure there are no surrender charges for rolling over an existing account.
Once you're the proud owner of a self-directed IRA with a custodian that can handle real estate, what's next? There are specific rules as to what you can and cannot do with your real estate IRA.
Some Things You CAN Do:
- Your real estate IRA can buy and sell many types of real estate including raw land, rental properties, condos, fixer-uppers, commercial properties, ocean or bay vacation rentals, etc. Keep in mind it's the self-directed real estate IRA that buys, owns and sells the property... not you personally. You don't withdraw the money from the IRA to buy the property - the custodian buys the property in the name of your self-directed real estate IRA.
- The property can be rented but the rental income is paid into your IRA, not to you.
- All the expenses of renting and operating the property must flow in and out of your self-directed real estate IRA. Be sure your self-directed real estate IRA has enough liquid reserve funds to cover operating expenses, improvements, etc.
- It is possible to finance a property that is owned by your IRA. But the financing must be "non-recourse." That means the property, not the IRA account, is the sole security for the loan. Most "traditional" lenders won't provide non-recourse financing. However, seller financing, private loans, or working with specific lenders experienced with using retirement plan money to purchase real estate, are possibilities. Let me emphasize again: get good professional advice before taking any action.
- Your real estate IRA can buy a partial interest in a property. This is useful if your IRA doesn't have enough money to buy 100 percent of the property. For instance, it could partner with another IRA owned by you or one owned by another individual. Or, your IRA could partner with you using non retirement plan money.
Some Things You Can NOT Do:
- Your real estate IRA cannot buy a property that you, your spouse, or certain family members already own. Likewise, your real estate IRA cannot sell a property it owns to you, your spouse or certain family members.
- You, your spouse or certain family members cannot have any personal use of the property owned by your real estate IRA. Therefore, primary residences, second homes and vacation homes are not candidates.
- Your IRA cannot lease the property to your business. Your business cannot use or occupy any part of the property.
- If you are counting on having a rental property that produces a tax shelter from depreciation deductions, owning the property inside your IRA may not be a good fit. You will not report deductions and depreciation each year on your returns as you would with typical rental real estate ownership which can provide an annual tax shelter.
Is a Real Estate IRA Right for You?
So, now you know you can use your retirement account to buy real estate. But the bigger issue is should you use your retirement account to buy real estate? The answer is, it depends on the type of real estate and your unique situation.
You already know your real estate IRA cannot own property that is used by you, certain family members or your business. But other types of real estate, such as raw land, fixer-uppers, and rental properties, are perfect candidates. The profit from these investments would be taxed upon the sale
if you owned the property personally
. However, if your real estate IRA buys, owns and sells the property, the profit would remain in and compound inside your IRA
tax-deferred (or tax-free if it's a Roth IRA)!
Last But Not Least
- Before your IRA buys any property, you've got to understand how real estate works. There's a lot to it. Make a commitment to learn how to analyze a property before you buy it, including operating expenses and management considerations. Study the financial benefits such as cash flow, depreciation and appreciation. Learn how to determine cap rates, cash on cash and other rates of return. And so on. The more you know, the better your chance of success.
- Remember that real estate lRAs are a specialty and not every retirement account administrator/custodian or real estate agent is geared to handle them.
Folks, I hope you can see the huge potential of real estate IRAs. If the choices you've made so far for your retirement account aren't taking you where you want to go, find a new vehicle. Real estate opportunities are everywhere for those savvy enough to recognize them and motivated enough to take action.
There is a limit on how much you can contribute each year to your retirement account. But there's no limit on how much the account can earn! Hubba hubba! What a country!
P.S. Here's a good resource for you: "IRA Wealth" by Patrick W. Rice
P.P.S. Not long ago, I attended a 7 hour workshop sponsored by the Entrust Group, a well reputed leader in the area of administration services for self-directed retirement plans. To say that it was one of the more informative sems I have attended would be an understatement because while I went primarily to learn about real estate investing, I received a ton of info, ideas, and knowledge on all the latest strategies (including the just recently passed Pension Protection Act of 2006) on basic retirement planning.