Rental Properties in Your Self-directed IRA

For legions of investors frustrated with puny yields on savings and bonds, slow growth retarding stock market returns, and the usual substantial risk involved in security investing (any given stock or bond can potentially become worthless overnight), we have good news: The combination of declining real estate prices and steady or increasing rents have opened up a window of opportunity in real estate for income-oriented self-directed IRA investors. In fact, years after the “smart money” was selling off real estate ahead of the bubble collapse, we are seeing signs that smart money is getting back in the real estate market. Indeed, up to 20 percent of residential real estate now sold is sold to investors who are seeking to generate immediate positive cash flow.

Getting Started in Self-directed IRA Real Estate Investing

Owning property within a self-directed IRA is simple: Open an account with American IRA, a third-party administrator specializing in self-directed retirement accounts. Fund the account and direct us to purchase the property on your IRA’s behalf. We will work with your team of advisors to ensure that the property is titled and held in accordance with the IRS’s regulations pertaining to retirement accounts.

Using Leverage

If you can’t pay cash for the property, you can have your self-directed IRA borrow most of the purchase price. Typically, you can finance a property in an IRA with banks that specialize in non-recourse financing through IRAs which generally requires a down payment of about 35 percent, plus reserves. The loan must be a non-recourse loan, meaning the loan can only be collateralized by the property you’re buying, within a self-directed IRA a.k.a real estate IRA . You cannot sign a personal guarantee on the debt nor can your IRA or any other prohibited person. Fortunately, in many markets, it is still possible to generate substantial free cash flow from well-chosen rental properties, even carrying a mortgage of 2/3ds of the value of the property.

In addition to a 35 percent down payment, lenders will typically look to see if they can expect a positive cash flow of 20 to 25 percent, net of expenses. Again, this is very doable in many real estate markets today.

Looking for more flexibility? A self-directed IRA (Real Estate IRA)  is not limited to borrowing funds from banks that specialize in non-recourse loans, your IRA can also borrow from private lenders. Borrowing from private lenders has some added advantages to it as the terms and down payment are negotiable. When entering into loans with private lenders make sure to do your due diligence, use professionals to draw up the paperwork, and remember that the loan must be non-recourse.

One caveat: Because borrowed money is not IRA money, any profits attributable to borrowed money could be subject to unrelated debt income tax (UDIT). American IRA does not provide individualized tax advice – it’s important to retain your own tax advisor for advice on how this affects your personal situation.

Advantages of Holding Property in a self-directed IRA

IRAs allow you to defer all the income your rental property receives. This is a crucial consideration for real estate investors, because of the substantial amount of rental income, which would otherwise be taxable in the current year. If you hold the property in a Roth IRA, the income and potential capital appreciation is tax free.

Because there’s no current tax liability on rental income, you can’t take depreciation deductions on rental property you hold in your self-directed IRA.  However, you aren’t paying current year taxes on the property, it’s a wash. Real estate investing in tax-advantaged accounts does not rely on depreciation allowances to make sense. You can still frequently realize positive cash flow very quickly or even immediately, even without depreciation.

Note, however, that if you have leveraged the property, you can deduct all the normal expenses, such as interest, taxes, insurance and depreciation in the percentage applicable to the percentage of debt on the property.

For more information, or to explore your options, call American IRA today at 866-7500-IRA(472). We look forward to working with you.