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Investing in Real Estate, Notes and Trust Deeds with an IRA
IRA funds are typically invested in public stocks, bonds, mutual funds and money markets, but can also be invested in Real Estate, Trust Deeds, Mortgages, Promissory Notes and Private Stock/Bonds. It can be very lucrative to purchase your best and safest investments with IRA funds to avoid income and capital gains taxes. This works especially well if you have a large amount of money in your IRA account(s).
The first step is to determine if your current IRA custodian allows real estate and/or trust deed investments with your account (most don’t). If not, you can convert/rollover your IRA/401K into a “self-directed IRA” account. There are about a dozen custodians to choose from which specialize in self directed IRAs. Management and transaction fees vary from custodian to custodian, and are usually more expensive than a normal IRA account. Here is a list of “Self-Directed IRA Custodians”, its best to compare fee schedules based on the size of your account, types of investments you plan to purchase, and the number of trades you plan to do per year.
The second step is to combine IRA accounts. If you have several IRA accounts, combine them together to get a bigger bankroll. It is easier and more cost efficient to invest one self directed IRA account of $100k in real estate and notes, rather than three accounts of $33k each. You cannot combine a ROTH IRA with a Non-ROTH IRA.
Once your account is transferred to a “self directed IRA”, a process which usually takes 1-4 weeks, your account can be invested directly into real estate, promissory notes, trust deeds and other non traditional investments.
Self Directed IRA Restrictions and Prohibited Transactions
It is possible to now buy real estate, notes and private stock with your IRA funds with restrictions. Some of these restrictions (prohibited transactions) are:
Disqualified Person – The IRA holder and his or her spouse. The IRA holder's lineal descendants, ascendents (parents/children) and their spouses (brothers and sisters are ok). Any corporation, partnership, trust, or estate in which the IRA holder has a 50% or greater interest. Anyone providing services to the IRA, such as the trustee or custodian (See IRS Section 4975) for a complete list of prohibited parties credentials)
Buying Real Estate in an IRA
Advantages of owning real estate with an IRA:
Disadvantages of owning real estate with an IRA:
A Few Good Ideas for buying Real Estate with an IRA:
Investing IRA funds in Trust Deeds and Promissory Notes
Trust deed Investing with an IRA is an even better idea for investing IRA funds, due to the favorable tax treatment, the low maintenance requirements, and above average yields (12%+). It is best to buy very safe, low LTV, 1st position mortgages. Junior position notes are not advisable unless you keep a large cash reserve in your IRA account to cover possibility of advancing funds to a senior lien.
It is also possible to buy fractional notes in an IRA. As an example, if you would like to buy a 200k note but your IRA account has only 100k in it. You can buy 50% of it yourself and 50% with the IRA.
When buying real estate notes, sometimes the borrower defaults, and the note holder must foreclose and take back the property. In this scenario, the IRA would then own the property. Make sure that if you buy notes with a particular IRA custodian, that they also allow holding real estate (not all do). Should you take back a property in your IRA, you can now sell it or rent it, but you can’t move into it or use it personally.
Another great idea might be to buy discounted notes or an option on a note. This opportunity may be rare, but can have an astounding tax free rate of return.
Warning: Investing Self Directed IRA funds requires careful attention to IRS laws, violating IRS laws regarding self dealing, selling to disqualified buyers can be a serious taxable event and cause your IRA to be effectively distributed and penalized. The IRS has letter rulings on many of situations. Review these laws with your Self Directed IRA custodian.
About the author:
James MacArthur is broker/lender licensed by the California Dept of
Real Estate. We make “non-recourse IRA loans” in CA, as well as sell
trust deeds to Qualified California investors. I am not an attorney, and
this paper is not intended to provide legal advice. Consult your attorney
and IRA custodian for the latest information.