Using An IRA Or 401K To Invest In Real Estate

Before you go out looking for private lenders or partners, you need to understand one of the most powerful ways to get people to loan you money, and that is by showing people how they can loan money to you (or invest with you), using the money they already have invested in their Individual Retirement Account (or IRA for short).

In this section, we’ll also discuss how you can invest in real estate using your own IRA account.  If you don’t have very much money in your IRA account (or if you don’t have an IRA account at all), don’t worry.  We’ll not only go over the basics of setting up a new account but we’ll also discuss how you can grow your IRA account without ever making a contribution again!

The reason why most people don’t invest in real estate using their IRA account is because they do not know it can be done.  Many People especially don’t know that they can invest their IRA funds in private mortgages.  Most people think IRA investments are limited to stocks and mutual funds.  In fact, many accountants don’t understand how an IRA buys real estate or that it can even be done.

 

“TPAs” And “Self-Directing”

IRA accounts are handled by what is called a “Third Party Administrator”, which is referred to as a TPA.  You’re probably already familiar with this term if you have an IRA account.  If not, just think of the TPA as being like a bank who has your account.

The key to buying real estate using an IRA is to either setup the IRA account with (or transfer the IRA account to), a TPA who allows you to “self-direct” the IRA.  “Self-directing” means that you have direct control over the investments that the IRA account makes.  The TPA must also allow you to invest the IRA funds in real estate related investments.

We’ll discuss more about dealing with your TPA and self-directing more after we cover a little more about actually investing in real estate using an IRA account.

 

You Don’t Need Money In Your IRA To Buy Real Estate!

One of the biggest misconceptions about buying real estate using an IRA account is that you must have large amounts of money in your account.  There are people who are aware that they can invest in real estate using their IRA.  However, many of these people still don’t know that they don’t need any money in their IRA account to buy real estate.  After all, if you can buy real estate using no money down, so can your IRA!  Your IRA could even get cash back at closing.

 

The IRA Must Make A Monetary Investment

When having your IRA buy real estate with no money at all, some third party administrators will require that your IRA at least make some type of cash investment in the deal, even if it’s only $100.  This is mainly to create a paper trail to show that your IRA actually made an investment.  Still, putting 100 bucks down is still close enough to “no money down”.

 

Infinite Returns

One thing to keep in mind is that you cannot measure the return on your investment if you do not put any money into the deal. This is called an infinite return and there are no limits on the actual return your IRA can make on its investments.

 

Growing Your IRA Without Making Contributions

At some point you may decide you want some of the money you are making as a real estate investor to be put aside long term for your retirement, and investing the profits from just one or two investment deals today can turn into a retirement fund worth a fortune.

Most people’s objective is to have a tax deduction from their income every year by making contributions from their income, while at the same time building up a retirement nest egg that is tax deferred.  However, you don’t have to take money out of your pocket to be able to grow your IRA.  In fact, there is no reason to ever have to make another contribution to your IRA.  The way to do this is by growing your IRA using the profits it makes from investing in real estate.

Best of all, there is no limit on how much your IRA can make off of its investments, there is only a limit on how much you can contribute per year.

 

Allowable Investments

Most people are only familiar with the traditional IRA investment options and are not familiar with nontraditional options.  They simply make contributions to their IRA and then have a bank invest their money.

Basically, you are allowed to invest in any investment with your IRA as long as it complies with the law and you are with a Third Party Administrator which allows the particular type of investment.  However, for the purposes of this course, we’re only going to cover the IRA investment options which are related to real estate investing.

As for allowable real estate investments, your IRA can invest in (or own) just about any type of real estate.  You can invest in…

Residential real estate

Commercial real estate

Raw land

Tax liens and certificates

Real estate judgments

Time shares

Mobile homes

And notes.  (Such notes can be current or in default, and you can lend money by creating new notes, which we’ll talk about more in just a minute.)

 

Finally, your IRA can even do…

Wholesale flips

Retail properties

“Subject to” deals

Agreement for deeds

Lease options

Straight options

And own rental properties

 

Prohibited Transactions

There are several types of transactions for which you are prohibited from doing using your IRA.

No “Self-Dealing” First and foremost, you can’t do what is called “self-dealing”.  This mainly means you can’t do any investments in which you can actually touch your IRA’s money.  This includes having your IRA buy a property from you or buying a property from your IRA.

In addition, your IRA cannot loan money to you on a property you have a personal interest in any way, shape, or form.  By the way, don’t try hiding the fact you’re borrowing from your IRA by placing the property in a land trust either.  If you get caught during an audit, the tax consequences can be harsh.

 

Can’t Operate As A Business

As a real estate investor, you must be careful not to run your IRA as if it were a business.  About 5 or 6 deals is the most you can do a year in your IRA.  Otherwise, the IRS could rule that you are running a business through your IRA and you wouldn’t be able to tax defer the IRA’s income.

To make the most money and grow as much of your investment portfolio tax deferred as possible, you’ll want to have your IRA only purchase deals which have the most profit potential.  All your other deals would have to be done in a separate entity.  If you have a spouse, you could even do another five or six deals in their IRA as well.

 

An IRA Cannot Guarantee Debts

Finally, your IRA cannot guarantee a note or a debt.  If your IRA takes over the payments of a loan, you yourself cannot personally guarantee the loan, nor can your IRA.  In other words, the property can be the only security for the loan.  The reason the IRS has this guideline is so that the only thing you (or your IRA) has at risk is the actual money invested in the particular investment.

There are some important things you should understand when it comes to you or your IRA guaranteeing a debt.

First, realize that if your IRA purchases a property with the intent to retail it, and at the same time the IRA takes out a private loan, neither you nor your IRA can guarantee the private loan.  This may be an issue for your private lender or it may not, if the lender is only worried about having the property as security.

Second, if your IRA Lease Options a property, it has not yet taken title, nor has it formally assumed the underlying debt.  The IRA would only be making a lease payment.  If your IRA purchases a property “Subject To” the existing mortgage, neither you nor your IRA will be guaranteeing the debt.  Not guaranteeing or formally assuming the debt is the whole point behind doing a “Subject To” deal anyway.

It is important to have a TPA who can walk you through the processes and tell you what you can and cannot do.

 

Choosing The Right TPA

Be sure to see the “IRA Companies” section of this website under the resources tab in the header menu.

Whether you plan to invest in real estate using your own IRA, or if you plan to show other people how they can partner or loan money to you using their IRA, you must know how to choose the right Third Party Administrator who allows “self-directing”. Not only that, the TPA you choose must allow real estate related investments and be able to handle the paperwork that comes with owning such investments.  Some companies do allow you to self-direct an IRA, but only with certain investments that do not include real estate or mortgage notes.  So be sure to get a list of investments the TPA company handles, before dealing with them.

 

Transferring To A Self Directed TPA

If you or your new lender currently have an IRA, it should be transferred to another administrator if the current administrator does not allow real estate investments. Different TPAs have different processes for transferring the funds in the IRA account, but it’s usually fairly easy and only consists of filling out and signing a few forms.  If you’re looking for people to invest with you using their IRA account, you’ll want to have these forms on hand so you can give them to your prospective lender and assist in transferring their account if needed.

Transferring an IRA to another TPA is not considered a roll over, so don’t worry.  In addition, you can transfer your funds from one TPA to another as many times as you wish, but you are only allowed to do this once in a fiscal twelve-month period.  To transfer the IRA funds, some people actually take all the money out of their existing account and then send the funds to the new TPA.  In this case, you would have 60 days to get the funds to another TPA.

Fees Before transferring an existing IRA to a different TPA, or setting up a new IRA, you should find out what their transfer fees are and make sure they will make payments from the IRA for mortgage payments, property insurance, and other related property expenses.  Most TPAs will charge a small set-up fee and a small monthly fee to collect various rent and mortgage payments for an IRA.

 

Borrowing Or Lending Money Using An IRA Account

One of the main reasons why IRA accounts are a hot topic among real estate investors is because, not only can you buy real estate or lend money using your own IRA account but you can show other people how they can lend you the money they have in their IRA as well.  For this reason, you need to understand how to transfer and manage an IRA account even if you don’t have (or plan to have) an IRA account of your own.  This will allow you to show other people that you are knowledgeable about investing using their IRA.

Compound And Grow The IRA Faster You’ll also want to be able to show people how investing their IRA funds in real estate will help them to compound and grow their retirement funds faster.

For example…

If someone is investing a $50,000 IRA account at a 7% yield, after 5 years their account would be worth $71,239.23.  However, by investing that same $50,000 in private mortgages at 15% interest, after 5 years the account would be worth $105,801.94.  That’s a $34,562.71 difference just by investing the same funds they’re already investing at a higher yield.  This doesn’t include the fact that they might be receiving prepayment penalties which could increase the yield to 20% or more per year.

If you take these same numbers and increase the term to 20 years, a 7% yield would make the IRA account worth $204,541.58, while a 15% yield would have grown to $993,260.87.  That’s an astounding $788,719.29 difference and again, this doesn’t include any prepayment penalties which might have been collected!

 

Getting The IRA Funds To The Closing Agent

To create a new loan from a self-directed IRA, you’ll need to contact the TPA and see what forms must be submitted in order to get funds transferred to the closing agent on the property.  You must make sure the TPA and closing agent work together so that the loan documents are properly drawn up in the name of the IRA account and that the owner of the IRA does not unknowingly (or inadvertently) violate any “self-dealing” rules.

All the payments on the loan to the IRA must be made out in the name of the IRA and the funds should never be touched by the IRA’s owner.  Most TPA’s do charge a small monthly fee for collecting and depositing such payments.

Finally, when the loan is paid off, the name on the payoff check must be in the name of the IRA.  To help avoid any problems, the check should be forwarded directly to the TPA by the closing agent.

For more on how to talk to new lenders about the details of making private loans, be sure to read the section in the Contacts Quadrant module under the chapter on Private Lenders entitle “Answering A New Lender’s Questions”.

 

Buying Property Using An IRA Account

When having your IRA buy a property, it is very important for you to work with a competent TPA and that you make sure you don’t violate any “self-dealing” rules.

 

Getting The Funds Out Of The IRA To Buy The Property

First, when getting a check from your IRA to purchase a property, the check should always be made out to either your title company or the seller of the property.  The TPA can mail the check directly to you as long as your name is not on the check.  You can then either give the check to the seller or the title company.

By the way, don’t give the seller a personal check of your own to hold until they receive the check from your IRA, nor should you have your IRA reimburse you directly for such a check.

 

Titling Property

When buying property using your IRA, you don’t buy the property in your name, but rather in the name of your IRA account.  The title to the property must transfer directly from the seller to your IRA.  Title is not allowed to pass from the seller into your name and then to your IRA.

Your TPA will guide you on the correct name to use for the title on the property.

 

Using Land Trusts

For liability reasons, you should not have your IRA take title to a property directly. You should put the property in a trust and have your IRA own the beneficial interest in the trust.  In this scenario, the IRA does not own the property, but rather the IRA owns the interest in the trust and the trust owns the property.

If you title the property directly in your IRA’s name, your IRA is liable for that property.  Even if you have homeowners’ insurance, if a tenant or someone else were to have a major injury at the property, they could get a judgment against the owner of the property, which would be your IRA.  This would mean that everything in your IRA is susceptible to a judgment or lawsuit.

To protect yourself, make sure your TPA is familiar with using land trusts and is able to properly counsel you on using them when buying property with your IRA.

 

Selling The IRA’s Property

When selling a property that is in your IRA’s trust, it is recommended for you to have the closing agent make the proceeds check out in the name of your IRA and send it directly to your TPA.  If the closing agent makes the check out to the trustee (which could be your corporation, yourself, or someone you trust), simply endorse the check and send the check to your TPA.  Do not cash the check and then forward the funds.

 

Buying Discounted Notes

One of the allowable real estate investments we spoke of earlier was mortgage notes. Not only can you create new notes by lending money, but you can also buy existing notes.  Many note holders are willing to discount the note they are collecting on so they can have their money today, rather than collecting payments over a period of time.  If you have money in your IRA, buying notes at a discount has the potential to make some very high yields.  For instance…

If you buy a $50,000.00 thirty year note for $20,000.00, realize that most mortgages are paid off within four to seven years.  This is because most people move on the average of every four to seven years, which in turn means they will sell the property and pay off the mortgage note early.  The remaining balance on the note will usually be right around $48,000.00.  Combine this pay-off amount with the payments that you collect and the total amount received would be over $50,000.00.  All for an initial investment of $20,000.00, and received within a four to seven year period.

 

Buying Defaulted Notes

You can also buy defaulted notes and mortgages that people are not making their payments on.  You may ask… “Why would I want to buy a note that is in default?” The answer is… “So your IRA can foreclose and get the property which is secured by the note.” This is referred to as “buying the property through the back door”.

If someone is not making the payments on a note, that note has an extremely low value thus, lowering the amount you will have into the property.  To calculate how much you will be paying for the property by the time the process is done, you simple add the price you’re paying for the note, to the court costs and attorney fees for the foreclosure.

Strategy You can also build money in your self-directed IRA by having your IRA buy real estate with little or no money, fixing the property up, and then having your IRA sell the property for a profit and putting the money in your IRA. You can then use the money you build up in your IRA to buy notes and mortgages, or to make private loans at rates around 10% to 15%.

 

Wholesaling Properties With Your IRA

One of the quickest ways to build money in your IRA is to flip properties.  You can do this by either agreeing to purchase the property using a standard purchase and sales agreement, or by using a standard option agreement.

As we stated earlier, you don’t want to violate any “self-dealing” rules.  Therefore, make sure everything is done in the name of your IRA, that all deposits or option fees come directly from the IRA, and that all profits from the flip are deposited directly into the IRA account.

 

Flipping Properties Retail With Your IRA

IRAs can also be used to buy, fix-up and flip properties.  Just like when flipping properties without an IRA, flip deals can be done without requiring any money from your IRA (if you can finance the entire deal using private money or around the existing financing).  Do remember though, your IRA needs to have some money invested into the deal, even if it is just a hundred dollars.

Can’t Guarantee Hard Money Loans There is one problem though, which we said earlier… neither your IRA nor you, can guarantee any loan your IRA gets from a private lender.  Therefore, the lender must be willing to use the property as the sole source of security.  Sometimes this will be a problem, and sometimes it won’t.  It really just depends on what the particular lender’s guidelines are.

 

Paying For Repairs

If you need to do repairs on a property, or otherwise have expenses on a property while it is owned by your IRA, you can have your TPA issue a check from your IRA for the expenses.  It is OK to spend money out of your pocket for repairs and then get reimbursed from your IRA later.

 

Lease Optioning Properties With Your IRA

Your IRA can even Lease Option and Sub-Lease Option properties.  As with all agreements on properties owned by your IRA, the IRA should be named as the optionee or optionor.

Option Fees When Lease Optioning properties, it is very easy to get into properties without having to put any money down; however, as with all investments your IRA makes, your IRA should have money invested to make the deal a legitimate investment.  So, when Lease Optioning a property with your IRA, you should at least put down a hundred dollars (directly from the IRA to the seller), as an option fee.

 

Sub-Lease Options

If you Sub-Lease Option a property your IRA either owns or is Lease Optioning from a seller, make sure all the payments that come in from the tenant/buyer are made out to your IRA.

 

Rental Properties In Your IRA Account

Just like with Sub-Lease Options, the rent payments should be made out directly to your IRA account.  Some TPAs will even collect the rent payment on the property and make any underlying mortgage payments for your IRA.

Having rental properties in your IRA long term (such as more than a year) could trigger the IRS treating the transaction as a business transaction, which could have severe tax consequences.  Therefore, you should only put properties in your IRA you plan to own for less than a year.  This means you probably won’t be owning any rental properties in your IRA, which brings us to our next topic, which is when not to buy property in your IRA.

 

When Not To Buy Property In Your IRA

Investments Longer Than A Year

As I just said, you should not have your IRA do deals which would take more than a year.  This would usually be rental properties and Lease Option deals to tenant/buyers who most likely would not be able to qualify for a refinance within a year.

 

Limit On Number Of Deals

One of the things I also said earlier was to avoid doing too many deals using your IRA; otherwise, your IRA could be classified as a business.  Doing five or six deals a year with your IRA account shouldn’t be a problem.

 

When You Want The Profit Now

Finally, if you need the money your investments are making now, then don’t structure your deals so that your money goes into your IRA.

If you have your IRA purchasing and selling deals, and you keep turning right around and pulling the money back out of your IRA, you’ll be defeating the purpose of why you put the money in there to begin with.  The whole point of putting money in your IRA is so you can build a retirement account either tax free or tax deferred.

If you want the money so you can spend it, don’t have your IRA do the deal to begin with.  You would have to pay income tax on the money you take out before you are 59 ½ years old and there is also a ten percent penalty, and if you have a Roth IRA, you can’t take money out within five years without getting hit with penalties.

 

Opening An IRA Account

If you don’t already have an IRA account, opening one is easy.  You can open an IRA account with as little as a couple of hundred dollars and there are no age restrictions on how old you have to be.

The first thing you should decide is what type of IRA account you want to open. While there are several types of IRA accounts, the two most popular types of accounts are a Traditional IRA and a Roth IRA.

These two types of IRA accounts have many differences, but there are few specific differences we should discuss.

 

A Traditional IRA Vs A Roth IRA

The first difference is that contributions to a Traditional IRA are tax deductible and the contributions you make to a Roth IRA are not.  This particular difference should not matter much as a real estate investor, because you can grow your IRA without making contributions.  If you do plan to make contributions and are looking for the tax deduction, this would be a factor to consider when deciding on the type of account you want.

The main difference you should consider is the fact that while contributions to a Roth IRA are not tax deductible, the money in the account can be taken out “tax free” after age 59 ½.  This means your Roth IRA could make money by investing in real estate and never have to pay tax.  This means the money in the Roth IRA can compound “tax free” as well.

On the other hand, while you do get a tax deduction for contributions to a Traditional IRA, the money only compounds “tax deferred”.  This means you would have to pay tax on your distributions after age 59 ½.  For this reason, if you do not plan on making regular contributions (or are not looking for the contribution tax deduction), a Roth IRA is a better choice for you as a real estate investor.

There are some other important items you should know about.

First, with both a Traditional IRA and a Roth IRA, there is a 10% penalty if you withdraw funds prior to age 59 ½.  If you have a Roth IRA, you also can not take any money out within the first five years without paying a penalty (even if you happen to turn 59 ½ within that period).

Finally, with a Roth IRA, you’re never required to take a distribution, while with a Traditional IRA you’re required to take distributions after age 70 ½.  In addition, with a Roth IRA your children can inherit the account income tax free, where as with a Traditional IRA they can not.

 

Having Two IRA Accounts

If you already have a Traditional IRA and you decide you want a Roth IRA, you can have both, because there is no rule against having two IRA accounts at the same time. So, if you don’t want to pay the taxes or penalties to transfer to a Roth IRA, you can simply open up a Roth IRA in addition to your regular IRA.

 

If You Have A 401(k)

If you have a 401(k) with your employer, you can ask your employer to move your 401(k) funds into a self-directed IRA.  There is no penalty to transfer funds from your 401(k) to your IRA or Roth IRA, but you may not be able to move the funds in your 401(k) if your employer will not allow it.

Individual(k) Another type of account you may want to look into is an Individual(k) plan.  This plan is very similar to a 401(k) but is complex and is specifically designed for small businesses with few (or even no) employees.

 

Who Can Set Up An Account For You

Once you have decided on the type of account you want to setup, you can open an account through a bank, mutual fund company, trust company, securities company, or an accountant.

Make sure the company you choose allows you to “self-direct” and allows real estate type investments.  They should also be able to answer any remaining questions you may have to make sure you are making the correct decision in regards to your personal situation and objectives.

Just check out the “IRA Companies” section on this website which is listed in the Resources section.  All the IRA companies listed there allow self-directing.