This is part one of a two part series on how you can invest in Real Estate using your retirement funds that are in an IRA or Qualified Retirement Plan. The following is for educational purposes and you should always consult with your legal and accounting advisers to review your specific situation before taking any actions with your retirement accounts.
As I talk to friends of mine, many of them don’t understand the flexibility that they have using funds in their retirement accounts to invest in things other than Mutual Funds, Stocks and Bonds. Those are the mainstay alternatives that the Financial Services industry provides when you use a standard IRA or 401k account. They want to make sure that they continue to control the 15 TRILLION DOLLARS that are in these accounts (as of 2018). You need to remember that an IRA or 401k is just a tax deferred account and the company you work with, like Charles Schwab, is the custodian of that account.
There are other Custodian’s in the industry that allow you to invest with your IRA in just about anything, except those things that the IRS does not allow. There are only five major areas that you can’t invest in using an IRA: Real Estate for Personal Use, Life Insurance, Antiques/Collectibles, Most Coins-with major exclusions and Derivatives. These custodian’s let you set up a Self Directed Individual Retirement Account (SDIRA) that allows you to invest in Real Estate, Precious Metals, Private Businesses, Notes and more.
So the purpose of this article is to make sure you are aware of this opportunity to diversify your retirement account funds into other investment options. As you know by now, if you have been reading my other articles, is that I love to invest in large Multifamily Syndication’s. All of these investments have been made with my RETIREMENT FUNDS from a Self Directed IRA and a specialized Qualified Retirement Plan.
So how difficult is it to open a Self Directed IRA (SDIRA)…not very. It is as simple as opening a SDIRA account with an SDIRA custodian and funding the account from a new IRA contribution or rollover from an existing IRA or 401k from a previous employer. You normally can’t use funds from your current employers 401k plan. If you are considering making an investment, you should remember that the rollover process can take up to thirty days depending on how responsive your current custodian is to your request. I would also strongly suggest you do a Direct Rollover from your current custodian to the new SDIRA custodian and not take possession of any funds from your current account. There are some restrictions you can run into and if you don’t get it done in 60 days your funds will become fully taxable…OUCH!
The link below has 46 custodians that specialize in this type of SDIRA account…take your pick.
The custodian will invest in IRS allowed assets based on your written direction which can take a few days to a week to accomplish. There are also SDIRA’s accounts that have more flexibility for you where you have Checkbook control. I would suggest using the custodian when you are getting started to make sure you don’t make any mistakes that turn your SDIRA into a taxable account.
Finally, you should be aware that your SDIRA can be required to pay taxes due to a tax rule called UBIT or Unrelated Business Income Tax. UBIT applies to your SDIRA if it uses an investment that leverages your IRA funds with Debt to produce income. This normally happens when you purchase real estate using both equity from your SDIRA and a Non-Recourse loan from a bank. A Real Estate Syndication also would be subject to UBIT since it uses non-recourse debt, although you would not see the impact of this until the sale of the property due to the depreciation that would offset your annual gains during the holding period.
This is a complicated subject that you should discuss with your CPA, but know that you may have to pay UBIT taxes on the portion of gain that relates to the leverage ratio used in the last 12 months to generate income. This taxable income is called Unrelated Debt-Financed Income (UDFI) and is taxed at a rate for Trusts and Estates and can be as high as 37%.
So let’s recap, you can use an SDIRA to invest in a lot more than Stocks and Bonds. It SHOULD NOT be your first choice to invest in Real Estate that uses debt to leverage your investment due to the UBIT tax that you will have to pay on your gain.
The GOOD NEWS is that in part two, I will be telling you how you can use your retirement funds to invest in leveraged Real Estate and NOT be subject to UBIT taxes!
Here’s to your Wealth and Happiness!
Dan Engdahl, Co-Founder Multifamily Connections, LLC