Financing Real Estate Investments From Retirement Account Funds

In this article we delve a little deeper into using money from your (or someone else's) retirement account.

How to use your retirement savings to build your real estate investment portfolio tax-free or tax-deferred!

Many people have the option to select their own stocks and mutual funds from within their retirement account, but what many people don't realize is that these same retirement funds can be used to buy real estate investments without having to take the money out of the retirement account as a distribution. Not only that, but when you do it right, you can even use the money in your retirement account to purchase leveraged investments, making your retirement account grow while using other people's money to fund it!

Does this sound too good to be true? Well it's not; it's just that many investment advisors don't even realize you can do this.

To be able to use your retirement plan funds for investing in real estate you will need to establish a "Self Directed Retirement Account" with a custodian or third party administrator that specializes in real estate. (There are about a dozen companies nationwide, including Entrust Administration Inc. in Oakland, Calif.; Lincoln Trust in Denver; Sterling Trust Co. in Waco, Texas; Pensco in San Francisco and Trustar Retirement Services in Wilmington, Del., that offer this service). Fees and services provided vary widely so it pays to shop around and ask what type of investments you can make with your money. Some administrators will hold the real estate on your behalf (which they are required to do to qualify under IRS rules) and collect rents while others only hold the investments.

Once you move some of your retirement funds from your existing administrator into your new account you'll be ready to use the funds for real estate investing.

What Can You Buy?

Most of these specialist IRA custodians will allow you to invest in land, residential single family or multi-family homes and commercial property. Some may also permit foreign purchases.

If you are not an experienced investor but you want to leverage your funds in the real estate market, you may be able to buy into someone else's project as a tenant-in-common in order to partially fund the project and share in the profits. You may also be able to buy into a real estate trust that is being managed by another real estate investor and which provides for interest income on the money from your funds as well as a partial distribution of the project's profits.

The Devil Is In The Details

If you fund your investment 100% from your retirement account you won't have to worry about "unrelated business income tax (UBIT)" which is levied on profits you make from investments leveraged using debt-financing. For example, if you mortgage 50% of the investment you will need to file a Form 990T with the IRS to allocate the earned income between debt and non-debt financing. (You can also purchase a partial interest in a property with another investor(s) as tenants-in-common and split the income and expenses between you according to your investment percentages). To use debt-financing with your purchase you will need to obtain a non-recourse loan, which means the lender's only recourse in the even of a default is to the equity in the property (they cannot come after your retirement account).

To purchase a property you issue a letter of direction to the administrator instructing them to purchase the property (after you have negotiated the purchase). The administrator will effectively purchase the property into your retirement account in exchange for cash removed from your account.

All the rents collected from the property must be paid into the retirement account and any expenses on the property must be paid out of the account. (Which means, if the rent doesn't cover everything, you will need to have additional cash funds to cover taxes and expenses in the account).

When you sell a property held in your retirement account, the cash proceeds from the sale flow back into your account ready for your next investment.

Buy Your Future Retirement Home

You can even purchase your future retirement home with your retirement funds at today's prices, rent it out until you retire (or reach retirement age -59½ or older), and then you can "distribute" your property by withdrawing it from your retirement account and using it as a residence or second home if you wish. (If you have a traditional IRA you will need to pay income taxes on the value of the property at the time it is transferred, but if you have the funds in a Roth IRA you won't owe taxes when you transfer the property, making the Roth IRA a great option if your investments will appreciate over time).

Things You Can't Do

You can't transfer investment property you already own into your retirement account. You also can't buy a vacation property and rent it to yourself or your immediate family. Essentially you cannot have any personal or business use or gain from the property. (Doing so may result in hefty tax penalties down the road).

Risks

Investing in Real Estate is not for everyone and there are always risks. Always consult a tax advisor to understand your own personal situation and try to find an investment advisor who understands Real Estate investments. However, whereas investing in the wrong stock can result in your retirement fund going to zero overnight, investing in the wrong property rarely if ever results in complete loss (even if the house falls down you usually are still holding title to the land!)

If you are already investing profitably in Real Estate and are comfortable with the risks involved, using some or all of your retirement funds can significantly increase the value of your retirement portfolio.

As always, consult professional legal and financial advisors before making investment decisions.