An alternative to stocks: Buying rentals through an IRA

By JEFF LAZERSON / CONTRIBUTING COLUMNIST

11/27/15

It seems that most everyone thinks about the stock market as the default choice when it comes to your retirement nest egg.

Real estate investing is a little known, yet old avenue that you can use to protect and grow your retirement investment dollars tax-free or tax-deferred.

“Self-directed IRA’s (individual retirement funds), 401(k) rollovers and self-employed 401(k)’s can be used to purchase real estate investments,” said Kaaren Hall, president of Tustin based UDirect IRA Services.

Everything must be done through your IRA, not you as an individual.

You must have an IRS-approved custodian to hold your assets. You can engage an IRA administrator to process paperwork and provide other administrative functions. Facilitators can be engaged in helping investors set up limited liability corporations and C-corporation IRA’s, according to the Pensco Trust Co. website.

Hall warns that you must stay away from prohibited transactions. This is where there is a personal direct or indirect benefit.

You cannot, as the IRA owner buy, sell or exchange assets from your ascendants or descendants. You cannot sell property that you already own to your IRA, nor can you have personal use of the property you purchase.

You are responsible to make sure all IRA bills are paid. All funds to pay expenses must come from the IRA.

As the IRA holder, you can pick property managers, tenants and contractors but you cannot directly manage the property or perform labor.

Your IRA does not have to pay cash for the real estate investment. Your IRA can obtain a mortgage.

This specialized non-recourse loan (meaning the lender can only take back the property and not come after you for any deficiency) is not available through a Fannie Mae conventional loan as Fannie does not lend to IRA’s or LLC’s.

Investment properties are exempt from California’s anti-deficiency law according to Ken McDonald, law partner at Santa Ana-based Lerner and McDonald.

It’s especially important in respect to any California properties to be sure there is non-recourse language in the mortgage note or this could be disallowed from IRA tax protection.

South Dakota-based First Western Federal Savings Bank, an IRA lender, offers loans for up to 60 percent loan-to-value on a three-year adjustable-rate mortgage (ARM) amortized over 25 years at 4.25 percent with 1 point. Or you can get a 20-year fully amortized fixed at 6.25 percent with 1 point,” said First Western Federal President Jeff Fullerton.

If you do borrow money for an IRA purchased rental, your IRA must pay something called UDFI or unrelated debt financed income tax, according to Jeff Hipshman, partner at Tustin-based HMWC CPA’s and advisors. The tax schedule for the income runs from 15 percent to 39.6 percent. This income is based on the portion of profits from the borrowed money only.

Hall urges you to do your due diligence on the property that you are thinking of buying to make sure it’s a good deal in the first place.

If you have questions or comments, please contact Jeff Lazerson by clicking here.