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The 7 Things to Know When Using A Self-Directed IRA For Investing In Real Estate

by Ken Corsini on June 6, 2014 · 9 comments

  
Using A Self-Directed IRA For Investing In Real Estate

Real estate investing is an excellent means of diversifying your funds and can be accomplished through a self-directed IRA (SDIRA).

There are several big pitfalls that investors can succumb to leading to a loss in tax advantages or causing you to suffer large fines and additional taxes. While you have a great deal of latitude in your investment options and control over the actual day to day process of the investments within a self-directed IRA, there are restrictions and regulations related to how you invest the funds.

Additionally, there are some mistakes that investors make that could do them in.

Using A Self-Directed IRA For Investing In Real Estate

Here are a few important considerations when using a self-directed IRA in your real estate investing:

1. Investments to Remain for the Benefit of the IRA

Many times investors forget that the investments made with the self-directed IRA are not to be used for personal gain or profit.

At the most basic level, investors need to remember that any money that is collected and any profit made from a self-directed IRA investment is strictly the property of the SDIRA until such time as you will be distributing it for retirement.

This means that you can’t take any of the profits received out of the IRA for your benefit or anyone else’s during the life of the investment and IRA.

2. Don’t Touch Rents Outside of Your IRA

When it comes to collecting rent for a rental property it can be very easy to simply take the money yourself, deposit it into your account and write a check to your IRA.

This practice is a huge violation of the regulations relating to IRA real estate investing. It is vital that income collected from the rental go directly into the IRA itself (or the LLC that has been created to hold the property for the IRA).

The property that has been purchased by the IRA must be maintained by the IRA. This means that all income should be deposited into the IRA bank account and any repairs that must be made or expenses associated with the property must be paid out of the IRA funds.

3. Disqualified Persons for Transactions

There are a number of individuals that are disqualified from transactions relating to a self-directed IRA.

You want to be careful who you deal with when it comes to your IRA transactions. You are not allowed to enter into any agreement or transaction with any lineal descendants or ascendants as well as your spouse.

This includes renting a property to one of these individuals, purchasing property from one of them or even hiring them to work for you to complete repairs and manage the property.

Additionally, you are considered to be a disqualified person when it comes to your self-directed IRA property investment. This means that you are not able to do the maintenance, cleaning or repairs necessary to keep the property up.

The best course of action is to hire a property management company for the job or to keep contact information on a handful of trustworthy professionals to handle the individual jobs.

4. Failure to Have Cash Available for Property Management Needs

Since it is a requirement that all money relating to the investment property held by a self-directed IRA be kept in the same circle, it is vital that you are prepared.

This means that if you have an unexpected expense related to the property, you must pay it out of the IRA investment account, just as you must deposit all funds into this account.

If you have an emergency or require urgent repairs, you need to take the funds to pay for these repairs directly from the self-directed IRA. Having a cushion of money in this account is essential to ensuring your investment is properly maintained and accounted for.

5. Applying for Credit Cards through the IRA

If you have set up an LLC for the investment property that you hold through your IRA you want to be careful not to jump into any of the many credit card offers you will get in the mail.

Lenders are fast to send out offers and applications for credit to new business owners, including those that create an LLC. Any type of a credit card held by or even applied for by a self-directed IRA or its LLC is considered to be a personal guarantee and prohibited by the rules of investing with your self-directed IRA.

6. Maintaining the Original Structure of an LLC

When structuring the LLC with multiple IRA investors you will want to be sure that you understand the division of the investment.

Those divisions will not be able to be altered after they are set up. This means that if one IRA investor contributes and owns 40% of the LLC and another IRA investor contributes and owns 60% of the LLC, those percentages cannot change.

If the first IRA investor decides to transfer some dollar amount out of the LLC and back to the IRA, the other partner has to do the same and in direct proportion to their ownership.

7. Hard Money Lending Considerations

In addition to the concerns related to self-directed IRA real estate investing, you may be considering investing in hard money lending. The short term (typically 6 to 36 months) that most hard money loans adhere to make it an excellent way to keep from tying up your IRA funds long-term.

While this is an excellent way to increase the funds in your IRA there are additional cautions that should be taken when investing for these purposes.

It is important to use the services of a custodian when you are investing in hard money lending. This ensures that there is an unbiased party handling the money and the details.

In addition, you must not lend to friends, family or yourself (or a company you own) in order to stay within the guidelines and away from prohibited people.

The most important consideration when investing your self-directed IRA funds in real estate is to remember that the IRA is a separate body with funds that you can control and invest in an effort to increase the value of the IRA, but that it is not money that you will have access to for any other reason.

This is ultimately your retirement plan and a vessel to help you mass the funds you need to retire as you would like.

How are you using real estate for retirement?

Be sure to leave your comments below!

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{ 9 comments… read them below or add one }

Paul Salmela June 6, 2014 at 12:34 pm

Good article. I’ve heard conflicting information regarding acting as a property manager on a property owned by a self-directed IRA. Is it your understanding that it’s okay to act as a property manager?

Also, I have heard some say that it’s okay for the owner of the self-directed IRA to perform some maintenance tasks as long as it doesn’t add to the value of the property. For example – the owner could apply some touch up paint in-between tenants. What are you thoughts on this?

Reply

Glenn Schworm June 6, 2014 at 12:52 pm

Hey Ken,

Good article, I could not help but add this piece which is obscure but important. We use Pensco as our SDIRA provider for our clients and have for over 5 years. Last year after talking to a possible lender here on Bigger Pockets we were introduced to another provider named APS, American Pension Services out of Utah, I believe. We did our due diligence on them and they have been in business for over 30 years and all seemed ok. We had one of our friends and investor put her funds with them to start an investment with us. Well, low and behold, the owners have swindled over $20,000,000 from fake notes and are now under indictment. Here is the challenge, the government has frozen all accounts until they sort the mess out. Thankfully we have our investors funds, but she can’t even close the account until it gets sorted out. My point was gong to be to do your homework, but in this case with a 30 year solid track record it doesn’t necessarily apply. I guess you never know. The moral of the story for this incident is to stay clear of APS for your SDIRA needs. I hope that helps some people who read this article avoid a major issue.

Glenn Schworm

Reply

Sharon Tzib June 7, 2014 at 8:14 am

Yeah, I saw that on the forums Glenn. That’s a shame. http://www.sensefinancial.com/ is owned by Dmitri Korobov on the BP forums. May want to look into his services.

Reply

Greg Jackson June 8, 2014 at 11:39 am

Glenn,

Thanks for the heads up. I’ve been using Pensco as well since last year (2013) and have been happy with the results.

Greg.

P.S. Solid advice Ken!

Reply

Thomas Phelan June 6, 2014 at 12:58 pm

Excellent advice but why would you use a Self-Directed IRA if you qualify for an Individual 401(k) that has many superior benefits, such as:

1. 56,000 potential annual contributions
2. Borrow up to $50,000 or 50% of the value of the 401(k)
3. Can have two components, ROTH and Traditional
4. Husband and wife can belong to the same Plan
5. No U.B.T.I. on Non-Recourse debt financing
6. No LLC needed, save annual filing fees
6. NO CUSTODIAN, save on annual fees

Reply

Sharon Tzib June 7, 2014 at 8:10 am

You mean a Solo or 401K. Yes, I agree, this was going to be my response. I think a lot of people let the self-employed qualification stop them, but it’s my understanding if you have a real estate business of any kind that generates income, you can still have a Solo 401K even if you have another “job.” The SDIRA rules are archaic compared to the Solo.

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Sharon Tzib June 7, 2014 at 8:11 am

Sorry, meant to say a Solo or Individual 401K.

Reply

Vania June 6, 2014 at 2:48 pm

Thank you Ken for writing this article since SDIRAs are a very useful tool for the investor, but need a great deal of care to avoid pitfalls while using them.

Reply

Loren Whitney June 9, 2014 at 8:14 am

Great Title to this article…

Reply

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