Investors See Benefit in Using IRAs for Real Estate
After the nation's financial crisis, Leslye Schiff decided she had had enough of the highs and lows of the stock market and pulled her money out. Instead, she rolled the money she had in her traditional individual retirement account into a Roth IRA and changed her investment strategy.
When her husband Rob left his job a couple of years ago, he rolled over his 401(k) funds into a Roth IRA as well. Now both of them are actively making their retirement dollars work for them through various types of real estate-related investments.
"Through meeting people and networking, we found could do other things with our IRA," says the Mission Viejo, California-based real estate investor. "We have made a nice amount of money with our IRAs instead of being in the market and worrying if it was going to tank. We're more in control of what we're investing in instead of the unknown."
Separate from her IRA, Schiff is a buy-and-hold investor with a portfolio of rental properties in Texas, Tennessee, Arkansas and Missouri. Now, with her IRA, she has expanded into tax liens in Illinois, a couple of real estate syndications, and is invested in gas and oil. She is also starting to invest in real estate notes.
"We're always rolling the cash into another investment. If it's sitting, we're not making any money on the deal," she says. "I think it's a great tool to use, especially with a Roth IRA, and you control what you invest in and you invest in what you want, instead of the market dictating what will happen."
Real estate wasn't always an option. Ever since they were created with the passage of the Employee Retirement Income Security Act of 1974 (ERISA), IRAs have been self-directed, because the investor always had the ability to direct the custodian of the account to change the investment mix -- whether it were stocks, bonds, mutual funds or whatever. The custodians at the time just decided not to allow real estate into that mix.
The ERISA statute itself only defines which investments are not allowed in an IRA. It says nothing about what investments are permitted. In all, there are only three types of investments expressly prohibited by ERISA: collectibles, certain types of precious metals and life insurance.
"All IRAs are self-directed. It's up to the custodians as to what assets they will hold," says Sandra Reese, founder of Sandra Reese Enterprises LLC, and an independent consultant based in Chicago who educates investors on alternative asset investing in self-directed IRAs.
However, it wasn't until after the Great Recession that the term "self-directed IRA" really came into prominence as a number of firms opened their doors, offering education and training on how to invest funds from an IRA in alternative vehicles, such as real estate.
"I think it's been slowly getting popular since the early 2000s, but it really kick-started after 2008. The big crash exposed a lot of the younger generation to the volatility of the stock market," says Nate Hare, executive vice president of Quest IRA in Houston, Texas. "Our target market has shifted. Now, we're getting the younger generation investing in IRAs for the first time and looking to save, but also looking for other options."
Investing is always a risk. But unlike stocks and bonds which are intangible, people can see and walk on real estate. Both investors and non-investors have experienced what it's like to buy or rent a single-family home, an apartment or a condominium sometime in their lives.
"In my eyes you minimize the risk if you invest in things you understand," Hare says. "We provide education and talk about the options people have. What it comes down to is to invest in what you know best. If you understand real estate better than the stock market, you will make a better return on something you understand."
As a consultant, Reese has had clients invest in many types of real estate through their IRAs. Those investments have ranged from income-producing properties (both residential and commercial), to real estate notes, mobile homes and even boat slips. Any form of real estate that has a deed or some evidence of ownership with it, including farmland, timberland, vacant land, raw land, foreign real estate, gas and oil royalties all present good investment opportunities.
For more passive investors, there are real estate investment trusts (REITs), real estate syndications and crowdfunding platforms, such as Realty Mogul and Patch of Land that are available to IRA investors.
"We have seen a definite increase in the popularity of crowdfunding as a tool in the purchase of real estate on our website," says Rick Sharga, executive vice president of Auction.com. "There is also a noticeable increase in real estate purchases by individual investors using their retirement funds than in the past."
Although the use of retirement funds in on the rise, Reese warns that investors considering using those funds remain aware that self-directing investments for their IRA means they alone are responsible for the investment decision. The IRA's custodian does nothing more than take direction from the investor.
A hands-off approach. By definition, an IRA is a way for people to put future retirement savings to work for them long before they retire. While the traditional IRA offers tax-deferred savings, the Roth IRA offers the potential for tax-free savings, so long as certain requirements are met (check out Internal Revenue Code Section 4975 for disqualified transactions).
For real estate investors, whether a flipper or a buy-and-hold investor with rental properties, using an IRA to fund investments is a totally different mindset.
"The IRA account owner cannot use his or her IRA funds to purchase a property they currently own. Additionally, the IRA owner cannot use an IRA-owned real estate asset nor can any disqualified person (IRC 4975)," Reese says. "The IRA account owner cannot perform any work on the IRA real estate asset, and all income and expense must flow through the custodian to protect the tax-deferred status of the account."
By law, all IRAs must have a custodian who holds the assets for the IRA owner. In addition, the custodian can also serve as the IRA's administrator, handling its day-to-day business. Conversely, an IRA owner can hire an administrator (maybe a more local company, for example) but that administrator must still use a custodian to hold the assets.
The title to all IRA assets is vested in the name of the custodian for the benefit of the IRA, and all proceeds from sale of assets or income earned must go directly back to the IRA. IRA owners can also set up a limited liability company, or LLC, for their real estate investments as an extra layer of liability protection. Frequently referred to as "checkbook IRAs," the LLC sets up a bank account with check-writing privileges for the owner, who can then directly pay for things that benefit the IRA's assets.
Hare, however, says forming an LLC for asset protection is unnecessary, and only stands to muddy the waters.
"You don't need it in an LLC. By definition an IRA is a trust. Since it's a trust it has it's own set of asset protection. In the IRA world you already have that protection because it is a separate entity from you. They can't come after you because you don't own it," Hare says.
In any case, a wise investor should speak with their accountant or financial advisor beforehand to decide which form of IRA is best given that particular investor's circumstances and goals.
Joel Cone is a southern California-based freelance business writer who specializes in the fields of real estate, economics and law. His articles have appeared both in print and online for many publications including California Real Estate, OC Metro, GlobeSt.com and The Los Angeles Daily Journal. He is also a contributor to Auction.com .
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