Despite rumors suggesting otherwise, yes, you can invest your Individual Retirement Account (IRA) and qualified plan assets (401(k)s, Roth 401(k)s, Defined Benefit Plans, etc) in different ways. As a matter of fact, you could, in fact, invest those assets into real estate and sometimes make a nice rate of return. Maybe as high as 20%. Few people know this information.
At first thought, putting real estate into an IRA or qualified plan may seem like an off-the-wall idea. It is one you might want to consider depending upon the situation, but you must be aware of the rules. The rules can be mind-boggling but sometimes the decision is a wise one. The concept is not new, but it has been slow to gain acceptance. Only a small percentage of qualified plan assets are invested in IRAs or qualified plans.
The 2007–09 bear market led some IRA owners to explore alternative investments. That was when the term “self-directed IRA” or “self-Trusteed Plans” entered the investing lexicon. As the stock market tumbled, a cottage industry of investment firms emerged urging IRA owners and 401(k) Trustees to assets out of equities and into real property, real estate notes, and real estate investment trusts (REITs).
In many instances a financial professional may resist your inclination to invest qualified plan assets into IRAs, 401(k)s, or defined benefit plans. They probably do not know much about such investing, plus, at times they do not have compliance arms that would allow such. Also, maybe more importantly, in some instances they can not get paid on such a transaction.
With respect to IRAs — no law prohibits an IRA owner from doing this, but many financial firms serving as IRA custodians do have rules against such a strategy. So if you want to invest in real estate through your IRA, you must first check to see if your IRA custodian will allow it. If it is allowed and you proceed, you are on your own: your IRA will be self-directed, your IRA custodian will make no effort to advise you about your investment choices, and you alone will be responsible for your investment decisions. That is a risk you may or may not be willing to take.
With qualified plans, where the business owner is a Trustee typically. The result, that entrepreneurs can make the determination of where the assets are invested as it relates to traditional stocks, bonds, mutual funds, etc. As a result, they can also make the choice to invest in real estate, per se. It can be income producing, land (with specific rules), buildings, apartments, etc. If the company has employees who are not related to the company a significant amount of care needs to be taken into account. The liability falls onto the shoulder of the business owner. The business owner who has thus become in charge of making the retirement of the employees/participants goes well. This is very important. The business owner now must jealously guard the interest of the participant monies, if you will.
Holding real estate in your qualified plan means looking at it differently. To a lesser or greater degree, the portion of the amount in real estate transforms from a dedicated retirement savings vehicle to a real estate investment vehicle. If you are more knowledgeable about the housing market than the stock market, you may prefer it this way. But be very careful.
Whether you know volumes about real estate or not, you must abide by the particular regulations and mechanics involved.
Self-dealing is outlawed. Legally, you can buy any form of real estate with your IRA and qualified plan assets, but you may not buy real property that will be used as your home or your place of business. Your IRA and qualified plans (which both are definition as trusts) may not purchase any real estate that you own, or any real estate that is owned by a business in which you or certain members of your family have an ownership interest. It is also barred from selling any real property it holds to you or such business entities.
If we are talking about an IRA — you buy or sell real estate through the IRA custodian. The mechanics of making the actual transaction are fairly straightforward. You instruct your IRA custodian to authorize the purchase or sale of a property, providing the required documentation to facilitate that purchase or sale. The IRA custodian then commences to buy or sell the property for your IRA, with the title to the property vested in the name of the custodian. You have to have enough IRA assets to cover 100% of property management and property-specific expenses linked to the transaction; failing to have sufficient assets to cover those costs may mean penalties or forfeiting tax benefits.
Talking about a qualified plan to include 401(k) or defined benefit plan?
If so, you are the Trustee, therefore need an accredited banking institution to comply with many of the same functions as an IRA custodian. You will need some consultation but the concept is the same as what was previously mentioned. Our company, www.VastSolutionsGroup.com, consults on complex transactions and should be able to help if you have questions.
Proceeds from sale & rental income go right back into the IRA or qualified plan. This is necessary so that the account may retain its tax-deferred status. These newly invested assets get the same amount of creditor protection the IRA and qualified plans affords to other assets. The level of protection varies per state, though, and IRA assets are not protected against civil lawsuits.
Do you need to form an LLC? Some owners of self-directed IRAs and qualified plans do just that, so that they can have checkbook control over the assets. How does this work? The LLC sets up a bank account for the IRA owner or qualified plan owner, allowing he or she to write checks on behalf of the IRA/plan. The LLC facilitates transactions for the IRA owner/qualified plan Trustee.
With respect to IRAs, there are some notable benefits to adopting the LLC structure. Timing can be everything when it comes to a real estate transaction, and having a “checkbook IRA” gives you a chance to buy foreclosures on the steps of your local courthouse with IRA assets. An LLC structure may lower some custodial costs associated with IRA administration, and it also permits the IRA owner the option of handling some property management duties such as bill paying, advertising, and collection and deposit of rents. On the other hand, since an IRA is a trust from its inception, the LLC structure is technically superfluous.
I should note, we have some advisors who suggest using an LLC and some who do not suggest so. Again, each circumstance determines the best route.
It should be noted, sometimes investing real estate assets into qualified does not make good investment sense. Specifically, taking a “tax advantageous” asset like real estate and invest it into a tax deferred environment goes against logic. Then again, if someone has no access to money but wants to put money into real estate, well, there you go.
If you want to hold real estate in an IRA or qualified plan like a 401(k), speak with a tax or legal professional first. You must understand what you are getting into, and the full tax details are beyond the scope of this video. Each circumstance is so different. Using your IRA and 401(k) to invest in real estate could be an auspicious move; it could also breed complications. Contact a professional if you are in need of assistance.
Copyright: R. Kenner French and VastSolutionsGroup.com
Kenner is an author, professional speaker, and family man living on an island — Bainbridge Island , WA.