Cash Flow Real Estate in Your IRA? You Betcha!

The folks on TV talk a lot about the importance of funding your IRA – and they’re always on about investing in stocks, bonds and mutual funds. Some of the more conservative pundits also mention annuities and CDs. But what if you’re not thrilled with the prospects for return in any of these assets?

After all, interest rates are still near record lows all along the length of the yield curve, and bonds may well not even keep up with inflation. Stocks, as an asset class, are limited by a slow outlook for growth – and stock dividends are nowhere near what they were a generation ago. Mutual funds? Well, you can’t get blood out of a stone. Fund returns are limited by the opportunities in the asset classes from which they come.

One option that is less well-known is this: Investing in real estate within your IRA. The tax code doesn’t restrict you to stocks, bonds, annuities and CDs in your IRA or any other retirement fund. In fact, with just a few restrictions on investing in life insurance, jewelry, gemstones, collectibles and certain forms of precious metals, you can take advantage of tax deferral in an IRA to invest in almost anything you can imagine.

Benefits of Real Estate

True, it’s not for everyone. Not everyone is cut out to be a landlord. But a good property manager is great for helping you eliminate this aspect of real estate investing. If you are comfortable with investing in real estate – and you have assets in retirement accounts you can put to work without relying on generating a current income – allocating part of your IRA to cash-flow positive real estate investing can make a lot of sense.

First, you can employ leverage – even in an IRA. As we all know, leverage is the key to making real estate investment work. Contrary to what some believe, your IRA can borrow money. It just has to be a non-recourse loan. That means you can’t use anything outside the IRA as collateral. The lender can only come after the IRA’s assets, and can have no claim on anything else.

Second, with a substantial down payment, real estate has a long history of generating substantial positive cash flow. This is important in a retirement account because there are certain restrictions on how much new money you contribute.

The Best Way to Create Cash Flow

The best asset there is for generating free cash flow is free and clear real estate. Investors find that paying cash for real estate inside their IRA can generate significant cash-on-cash returns that are substantially higher than those available in stocks, bonds, CDs or dividends. After all, lifestyle is based on cash flow.

Keys to Cash Flow Real Estate in an IRA

Build Equity Right Away. If you are not able to pay all cash but you can make a significant down payment, you can still create above average cash-on-cash returns using funds available in your IRA. When leveraging, most non-recourse lenders require a 35 percent down payment, plus cash reserves. This means you can leverage up to just under 2:1 on cash invested.

Maintain Adequate Liquidity. To increase safety, prepare for potential maintenance costs, prepare for vacancies, increase the predictability of cash flow and reduce your anxiety levels, it is important to keep available funds in your IRA. This is because retirement plans limit the amount of money you contribute in a given year. Other solutions include having your IRA borrow money or bring in a partner. However, with proper cash flow planning, you can eliminate a cash crunch as a potential issue.

Remember, the IRA is responsible for paying all of its expenses, including taxes, insurance and maintenance. The IRA is also entitled to all income the assets generate. The IRA’s beneficiary may not receive any benefits until they are eligible to take distributions, which is generally age 59½.

Observe Rules Against Self-Dealing. The IRS gives IRAs a substantial tax advantage in deferral of income and capital gains. In return, they expect you to treat the IRA as a long term asset designed to provide for your retirement security. You can use it for no other purpose. This means you can’t do business directly with your retirement account. You cannot hire your own firm to do the windows and the plumbing. You cannot act as a money lender to your IRA, nor can you borrow money from it. You also cannot stay in the property, even overnight, even if you pay the fair market value rental on the property.

Keep Transactions at Arm’s Length. The restrictions above don’t just apply to yourself. They also apply to your parents, grandparents, children, grandchildren, their spouses, and any businesses or other entities they control. However, the law does not specifically include brothers and sisters.

Understand the Tax Law. While your IRA may not be subject to ordinary income taxes, as long as the money is kept within the IRA, you do have to be careful if you employ leverage. In some cases, the IRS may levy a tax on your IRA’s profits attributable to leverage. This tax is called the unrelated debt income tax (UDIT). However, in some cases, self-directed Solo 401(k) plans may not be subject to this tax. Another tax, unrelated business income tax (UBIT) may apply if your IRA owns an interest in a partnership that employs leverage. This aspect of the tax code can get involved. For more information, consult your tax advisor, or call American IRA at 1-866-7500-IRA (472).