More answers to your many questions on Purchasing Real Estate in an IRA!

The response to my entry on the direct purchase of Real Estate using IRA assets was amazing. There were so many good questions that I decided to share some questions and answers. Let me know if you have more questions. Please note, we will use the word IRA, but many other types of Self Directed Retirement Plans (SDRP's) allow the direct purchase of Real Estate.

Q: We are getting ready to purchase some investment rental properties with our self directed IRA’s.  Can we discuss the following questions about our new self direct IRA?

A: Yes, but remember I cannot help you with tax, legal or investment advice as I am not not a professional advisor, simply an educator. If your current professionals do not know the answers, refer them to me and I can help them find that information or you can find new advisors. In this Blog, I do not recommend or point to any investments or advisors.

When real estate sales people invite me to speak about Real Estate in SDRP's, they generally do not want me to go deeply into rules on a leveraged purchase or Prohibited Transactionsand limit my time at the podium. When working with any vendor or sponsor of any investment, you should be doing your own due diligence on all parties involved.  You should research any vendor or sponsor you are considering investing with.  I have written an article on personal due diligence that you should read and consider before investing with anyone.

You can download more FAQ’s on Real Estate in an IRA and there is a decent article on UBIT at http://www.investorsinsight.com/blogs/retirement_watch/archive/2009/04/03/dos-and-don-ts-of-ira-investing.aspx 
 
Q: If we purchase investment rental property, I know you mentioned that the IRA requires a 35% down payment for a loan, is there a requirement on   how many years the loan documents are for (15 or 30 years)?

A: It is not the IRA that requires 35% down, but the commercial lenders who do the non-recourse loans required in an IRA or other SDRP. The lenders set the terms and conditions for the loan and I am aware of two larger lenders in this niche. You can see their websites at  http://www.iralending.com/  and at http://firstwesternfederal.com/IRA_Lending.aspx . There are frequently asked questions and a podcast available for you at www.iralending.com . I do not sell these loans or profit from them and you deal directly with the institutions. The loans are currently 30 years, fixed or variable.(around  8.25%) There are a number of fees associated with the loans.

If you find a private lender (which can be another IRA) who is not a broker,you can negotiate your own terms, including points, rate, term, down payment percentage, minimum loan etc. Currently the range of interest rates on this type of loan is 10-14% with 3-5 points (3-5% of loan amount) plus document fees and the duration of these loans are usually much shorter (2-5 years), but an individual (or their IRA) can choose to loan you the money for as long as they wish on whatever terms they wish. Finding the private lender is the problem. I do not connect borrowers and lenders for legal reasons and we do not service this type of loan. The best way to find this type of lender is by word of mouth.

Q: When we purchase rental from the IRA whose name needs to be on the loan documents?

A: Any asset paid for by the IRA is titled in the name of the IRA, through your TPA/Custodian. For example, the vesting would be something like: ABC Administration, Inc. FBO John Doe IRA # 12345. The vesting on loan documents would be the same as well as the escrow documents. When documents come to you from escrow, you will have to initial each page before sending them to your Custodian/TPA for execution.

Q: Whose name should the insurance policy and property management agreement be written in?

A: Always the name of the IRA when the property is held directly in the IRA. Your name should not be on anything connected with property owned directly by your IRA. This is an "Arms Length" transaction.

Q: Are the payments for the property taxes and insurance required to be in an escrow account paid through the IRA with the real estate loan?

A: Generally yes, but each lender has their own requirements, so you will have to check with each. Generally they require a 6 month PITI pad, which makes sense because you need a pad in the IRA in case the property is empty for an extended period, since the payments must come from assets in the IRA or new contributions.

Q: How is the rent check redeposited into the IRA, especially when property managers are collecting rent?  Where is the rent check sent to?

A; A copy of “property management contract” is generally required to be sent to your TPA/Custodian, if you utilize a property manager on the property. Monthly statements are also generally required by a TPA/Custodian.  Ask the property manager to make the net income check payable to your IRA as vested and be sure to have them reference the property address on the memo field.

Q: If there is a positive cash flow on the property does the full payment go back into IRA or can we use the positive cash flow to pay down the loan?

A: Remember this is full self direction, so you choose what to do with the excess cash flow from your property within the IRA. You can invest it somewhere else in something else or use it to pay down the loan, but don’t forget to accrue money for repairs, replacement of water heaters, furnaces, appliances, roof etc. New contributions to the IRA can be used to cover new expenses as well, but you need earned income to make contributions. If you take the profit as a distribution to pay bills you would have to pay applicable penalties and taxes and report the distribution to the IRS.

Q: Are purchases or down payment on rental/investment properties from Self Directed IRA’s with a positive cash flow considered to be debt-financed income property which maybe taxable by the IRS as UBIT (unrelated business income tax) or are purchases from self direct IRA exempt from these rules?

A: IRA’s are not exempt from UBIT. I have mentioned that there are rules for a real estate purchase in an IRA and UBIT does apply to the leveraged portion of an IRA purchase once the taxable income exceeds the IRS threshold ( I believe this is $1000, but check with your CPA). As I said, in an IRA, the leveraged portion of the purchase is subject to UBIT. This is not true for Purchase Money in an Individual (k) plan.

There is technical information on UBIT in IRS Publication 598. Just remember the key is that the IRS allows you to borrow money that you never earned and use it to leverage a real estate purchase in your IRA (that you may not otherwise purchase). In return, they tax the net return on only the leveraged portion and you keep the net gains after the tax, working tax deferred in the IRA. When you must file and pay UBIT taxes your CPA will probably use the 990-T form.

Q: What are the steps we need to take to start purchasing property from our self directed IRA?

A: While I cannot speak for the specific rules at each TPA/Custodian, I can outline the general steps in the process:

Steps to Buy Real Estate held directly in a Self Directed Retirement Plan (Real Estate Purchases inside an LLC or other entity will be handled differently)

1. a.Open an Self Directed IRA or Qualified Plan (401k, SEP, SIMPLE) Plan that allows Real Estate and other Alternative Investments. b.Transfer funds from another Custodian or fund with new contributions. You will be given an account number, make sure you write it down. Remember you should not make offers or earnest money deposits from personal funds on a property you want to purchase in your IRA. Get your account open and funded, then start buying.

2. Locate an investment Property

3. Make offer on the property in the name of your plan. (Earnest Money Deposit must come from Plan assets, not personal assets)

4. If offer is accepted complete a buy direction letter for your Real Estate, describing the purchase in detail, with a copy of the purchase contract. You will initial each page of your escrow documents before sending them to your TPA/Custodian for execution. Your TPA/Custodian signs the contract on behalf of your IRA and forwards it as specified to your Real Estate Broker/Escrow/Title companies - Once your TPA/Custodian receives documents for a purchase or sale, they will review the documents within a few business days. After the documents have been reviewed in the time frame outlined, they will contact all appropriate parties (client, title/escrow officer, sales team, attorney, etc.) for any corrections that may be needed. If there are no corrections, they will fund the transaction a few business days of receipt of the investment documents. If you need to expedite your transaction be prepared to pay rush or special handling fees to your TPA/Custodian.

5. At Closing, you read and approve all documents from title and escrow.

6. Title company sends approved docs to administrator who signs them on behalf of your plan (continued on page 2)

7. Rental or lease agreements must be assigned by the seller to the plan. New agreements made in the name of the plan. Property Management agreements are signed between the plan and the property manager.

8. TPA/Custodian sends funds  to title/escrow

9. Deed is recorded in the name of the TPA/Custodian FBO the IRA or QP and the deed is sent to your TPA/Custodian

10. All income is sent to Admin All expenses paid from plan in direct proportion to ownership

The process is not all that different than a personal purchase, just keep thinking of your IRA as a separate person from yourself and you will do just fine!