Investing with IRA funds

[Ravi Renduchintala]

While using an IRA to invest in property that's been foreclosed on is a fantastic option for increasing tax-free earnings, it's just as important that long-time and new investors know the potential pitfalls and benefits of such a move. Below are a few of the important considerations to make before investing your self-directed IRA into a foreclosed property.

Tip #1: Buy the foreclosed property.

Self-directing IRA investments into real estate has been legal since 1974. Of course, mot financial institutions don't allow the practice because they'd prefer you invest in their chosen stocks, funds and bonds instead. Makes sense, right? That being said, you can and in many cases should use your IRA to purchase a foreclosure property. Doing so could even open up more funds for other investments. If your retirement fund doesn't have quite enough in it yet to purchase a property outfit, you could even choose to own a portion of a home or property through a partnership with undivided interest or even get a non-recourse loan.

Tip #2: Put that property to work.

Owning the property isn't even half of the story. The key is to put that property to work earning money for you. Whether you decide to rent or to sell the property, the key is to make that income replenish and ultimately grow your IRA account over time.

Tip#3: Consider tax advantages and disadvantages.
The Roth IRA lets you grow all of your earnings tax-free because you're putting "after-tax" money into the fund. The Traditional IRA is a tax shelter until you're 59.5 years old, meaning you won't have to pay taxes on any earnings until you start taking qualified distributions at that age. Consider the potential earnings that investing in a foreclosure property will bring and that those earnings will be tax-free using a Roth IRA. Are you starting to see the obvious benefits of a Roth IRA now?

Above all else, it's important to educate yourself about your options. Do the due diligence and find the best self-directed IRA custodian to help you reach your goals and soon you too will begin enjoying all of the benefits of self-directed IRA real estate investing!

[Jon Holdman]

I've moved this to the correct forum for IRA discussion.

Mike Jones have a look in this forum because there have been several discussions of custodians. Experiences are pretty mixed.

I think there are a couple of issues to be aware of with actually using IRAs to own property. One is the money must come out of the IRA and go into the IRA. If the property needs repairs, those must be paid out of the IRA. If the IRA is tapped out, tough luck. You CANNOT just kick in some cash or use your credit card to pay. So, be certain your IRA has sufficient cash available to cover a nasty incident. On the flip side, returns from the property must go into the IRA. So, the rent has to go to your custodian, not you.

Another is that you cannot do any work to the property. That would be a contribution. So, little stuff you might do yourself still has to be hired out. I've been told (by an attorney who specializes in this are) that property management is OK, as long as the IRA doesn't pay you to do it. Others here have the opinion that its not. I think I'll skip being the test case the IRS uses to resolve this grey area.

Another is leverage. While some folks want free and clear rentals, the rate of return is generally higher on leveraged rentals. Its possible to borrow in an IRA. But few lenders do these fully non recourse loans. Those who do are at low LTVs.

And, if you do get leverage, you bring UBIT into the picture. That's Unrelated Business Income Tax. Its intended to level the playing field between tax exempt entities, including IRAs and taxable entities. There's an exemption to this tax for rents. But there's and exemption to the exemption for debt financing. So, if you're 50% financed in your IRA, 50% of the income is subject to this tax. Further, because of the way the debt goes down slowly and the basis for the property goes down as you take depreciation, the "debt financed fraction" will actually increase during the early years of your ownership.

A final problem is just getting custodians to move. If you have the furnace guy come out and fix the furnace, he's not going to be happy about waiting three weeks while you submit a request for payment to the custodian, they review it and then finally mail a payment. Yet that's what you're stuck doing with a traditional setup. The IRA LLC bypasses this issue, but puts much more burden on you to be careful with your money.