Personal Finance

How to Grow Your IRA From $5,500 to $204,345 With a Single Rental Property

Expertise: Business Management, Commercial Real Estate, Landlording & Rental Properties, Real Estate Deal Analysis & Advice, Mortgages & Creative Financing, Personal Development, Real Estate Investing Basics
126 Articles Written
IRA-build-wealth

Most people, even savvy real estate investors, underestimate the amount of money an IRA can save over time. Initially, small accounts can grow into very large accounts, especially in combination with leverage.

Want more articles like this?

Create an account today to get BiggerPocket's best blog articles delivered to your inbox

Sign up for free

To illustrate this point, here’s a not-so-crazy scenario that I got from tax attorney/CPA John Hyre (that way, if the numbers are wrong, I have someone else to blame). 🙂

How to Grow Your IRA From $5,500 to $204,345 With a Single Rental Property

You’re 40 years old and contribute $5,500 to your Roth IRA. I’m going to show you how you can pull $204,345 out of that single rental property over your lifetime.

The Roth purchases a rental for $27,000 (including renovation and closing costs), and you borrow 100% from an investor (paying 6.75% interest over 8 years). We’re leaving our initial $5,500 in the account for reserve.

The rental produces $675 per month in rental income, and expenses are 40% or $270, so the net rental income is $4,860 per year.

Your IRA can't keep all of that because you have loan payments of $4,377 and you have to pay a special tax called the "UBIT" in the amount of $306. So at the end of year one, your IRA only really gets to keep $177.

At the end of 8 years, you are 48 years old and the Roth IRA owns one free and clear property plus it has $5,225 in the account. There are no more loan payments or UBIT taxes, and the property now produces $4,860 in net cash flow per year (assuming you never raised the rent).

wholesale-flip-case-study

Related: 3 Solid Strategies for Investing With a Self-Directed IRA

Let’s assume the IRA cash flows that way for the next 12 years (until you turn 60). That means after 12 years, you have $63,545 in the account.

Now that you’re 60, you can pull money out of the Roth IRA totally tax-free.

Let’s assume you live for another 30 years. That means you’re pulling another $145,800 of income out of that single property, for a total of $204,345 — all from a single $5,500 contribution to a Roth IRA and one rental property.

And that doesn’t even include appreciation and rent increases. Or the fact that you never contributed any more to your IRA!

Now imagine if you did that a few more times!

Using IRAs to Raise Money

IRAs are also a great way to raise money for your real estate projects from others. There is a TON of money in people’s IRAs, and it’s hardly making any kind of return.

Most people don’t know that you can legally invest your IRA in someone else’s flip or multifamily project. And instead of making a 4% return people can make much higher rates of return — all by investing with their IRAs.

This is called “self-directed” IRA investing. And it’s a huge untapped source of capital for your real estate deals.

Other Cool IRA Plans That Let You Build Even More Wealth

Have you ever heard of a CESA plan? I hadn’t until recently.

CESA is short for “Coverdale Educational Savings Accounts” that let you make tax deductible contributions each year and use that money to pay for education-related expenses.

And when I mean education-related, I mean anything related to K-12 and college education, including the computer and office supplies — for the entire family.

Then there are the Health Savings Accounts (HSAs) that are similar and let you pay for health-related expenses tax-free. And you can even invest with them like you can with an IRA.

Totally cool. It’s amazing the difference a little bit of knowledge makes.

But Here’s the Catch

While IRAs are an extremely powerful to build incredible wealth over time, you have to play by the rules.

There’s something called “prohibited transactions” (or “PTs” for short) that disallow you from using your IRA in certain ways. Whenever you invest your IRA, it has to be an “arms-length” transaction, i.e. one in which you don’t directly or indirectly benefit (only the IRA can benefit).

The challenge is that the IRS regulations define PTs quite broadly. For example, is it likely that you can't lend money to the contractor who is renovating your house? Most likely not. That's because you lending him (or not lending him) money could indirectly benefit you in terms of his enthusiasm to finish the renovation project.

The problem is that if you have a single prohibited transaction in your IRA, even if it's a tiny loan you made to a relative (also a PT), you can destroy your entire IRA account that you've diligently built up over a lifetime.

podio-real-estate

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

It’s critical that you have a thorough understanding of the prohibited transaction rules.

After learning about how strict and narrow the PT rules are, it’s a good idea that before you invest your IRA in anything, you consult a good tax attorney first.

So, two lessons from today:

  1. Educate yourself about the ins and outs of the different IRA plans. Learn all you can about prohibited transactions; and
  2. Implement every IRA plan you can and incorporate it into your real estate investing (either your own or by raising money from other people’s IRAs).

How have you used your or other people’s IRAs in your real estate investing?

Let me know with a comment!

Michael Blank is a leading authority on apartment building investing in the United States. He’s passionate about helping others become financially free in 3-5 years by investing in apartment buildi...
Read more
    Susan Maneck Investor from Jackson, Mississippi
    Replied almost 4 years ago
    How did you get a no-recourse loan for your IRA?
    Michael Blank Rental Property Investor from Northern Virginia, VA
    Replied almost 4 years ago
    ?There are banks that do non-recourse, but the down payment requirement is usually 40% to 50%. Private money is negotiable, as long as the lender is not a “disqualified party”. That’s the approach that the gentleman I mentioned in the article I used.
    Dmitriy Fomichenko Solo 401k Expert from Anaheim Hills, CA
    Replied 10 months ago
    Here is a list of lenders offering non-recourse loans to IRAs and 401Ks that I’ve put together over the years, some will lend up to 70% LTV depending on the location and property type: https://www.biggerpockets.com/member-blogs/2810/50272-list-of-non-recourse-lenders-for-self-directged-ira-and-401k
    George Smith Investor from Latham, New York
    Replied almost 4 years ago
    You can buy a property in the iras name by borrowing 100% from someone else?
    William Morrison Investor from Silver Spring, Maryland
    Replied almost 4 years ago
    It’s called a Non-Recourse loan and can only be guaranteed by the assets in the IRA. Commercial loans can be the same. It’s UBTI in an IRA and not in a 401k.
    Dmitriy Fomichenko Solo 401k Expert from Anaheim Hills, CA
    Replied 10 months ago
    The assets in an IRA CAN NOT be used to guarantee the non-recourse loan. Only the underlying property is the security for the loan. For this reason lender takes higher risk and normally require 30-50% down. So the answer to your question George is NO – you can’t buy a property in an IRA using 100% financing.
    Scott Leach from Houston, Texas
    Replied almost 4 years ago
    I am having trouble understanding the numbers. In the second paragraph it says that the ROTH purchases a rental for $27,000 and you also borrow 100% from a lender. Is the money borrowed from the lender to repay the IRA? The wording makes it sound like $27,000 is taken from the IRA, then money is borrowed from a lender, and then the normal $5,500 annual IRA contribution is put back in the account for a ROTH IRA balance of $5,500?
    Michael Blank Rental Property Investor from Northern Virginia, VA
    Replied almost 4 years ago
    In the example, 100% of the $27K is borrowed from an investor, but the asset is TITLED in the name of the IRA. Does that make more sense?
    Matthew S. Investor from Vienna, Virginia
    Replied almost 4 years ago
    This sounds good, but how many investors are going to trust someone a 100% loan for their IRA to buy a house, backed by only a few thousand reserve in the IRA? What could possibly go wrong?
    Dmitriy Fomichenko Solo 401k Expert from Anaheim Hills, CA
    Replied 10 months ago
    This is unrealistic example. And BTW, the loan is backed by the house only, all other assets and cash in the IRA can’t be used as a collateral for a loan, that is what non-recourse means.
    William Morrison Investor from Silver Spring, Maryland
    Replied almost 4 years ago
    My Non-Recourse loans are closer to 60/40 with an additional reserve. The 60/40 is based on the rent, estimated quality of the neighborhood, curb appeal and a minimum value of the rental property much larger than this one. But I’m not trying to borrow from my sister, grandmother or friends.
    William Morrison Investor from Silver Spring, Maryland
    Replied over 3 years ago
    Matthew your comment had me thinking and grinning. Then these thoughts came to mind: You can tell a lot about a future partner by what risk they would suggest you take on their behalf. Think about both sides of this arrangement, the lender and the owner of the IRA. You see a loan with high risk and low reward that the IRA owner is proposing. It’s a non recourse loan only guaranteed by the assets of the IRA. It has a high rent to asset ratio for a reason. If the lender is using their IRA for the loan resources, you would add here the cost of setup an account capable of lending money. Not cheap to setup, one time cost. Then the annual fees and expenses for a high risk loan with relatively low risk reward return. So if this individual would encourage you to participate in this endeavor, would you partner on anything else with them? Or does it tell you more about them than they realized?
    Michael Blank Rental Property Investor from Northern Virginia, VA
    Replied almost 4 years ago
    Yes, but if you’re familiar with and avoid prohibited transactions then you can avoid the “catch” -;)
    Adam Bray Real Estate Agent from Pasadena, California
    Replied almost 4 years ago
    The initial headline and the content of this post is really misleading. Suggesting that an IRA of $5,500 can be used to generate some magically large return by using it as collateral (in some way) on a loan for an investment in a flip property is really not good advice for many people. The self directed IRA options that are out there are pretty good if you can lend the money to arms-length entities or use them to purchase properties directly. Beyond that, there’s not a lot of ‘creative’ ways to use the capital.
    Adam Bray Real Estate Agent from Pasadena, California
    Replied almost 4 years ago
    The initial headline and the content of this post is really misleading. Suggesting that an IRA of $5,500 can be used to generate some magically large return by using it as collateral (in some way) on a loan for an investment in a flip property is really not good advice for many people. The self directed IRA options that are out there are pretty good if you can lend the money to arms-length entities or use them to purchase properties directly. Beyond that, there’s not a lot of ‘creative’ ways to use the capital.
    John Vetterling from Louisville, Colorado
    Replied over 3 years ago
    I’m interested in seeing what some of the CPAs have to say. 1. I don’t think your UBIT taxes go away when you pay off the loan. 2. I doubt seriously if the tax deferred status of your IRA outweighs the tax advantaged nature of rental income. I suspect you would have higher net after tax returns from simply buying the property outside your IRA. Your deductions from interest, depreciation, and repairs offset the income, making it essentially tax free income.
    William Morrison Investor from Silver Spring, Maryland
    Replied over 3 years ago
    John, for your UBIT question ask your CPA about the 12 month rule. One really good recourse on this site is @Dmitrity Fomichenko with Sense Financial. He and his firm are excellent at the whole process to include annual follow up. The second question to ask is who on their staff has dealt with the IRS. A couple good sources for self education so you can ask your CPA and Attorney good questions when you get your responses are: Leverage Your IRA by Matthew M. Allen Best price is on the NASB site. and Live Tax Free Forever (through Your Solo 401k) by Michael J. McDermott It is like a lot of real estate and financial books that really have an important message but limited scope. So some fluff to justify a book, but worth it. A third but much drier and a tough read is: The Self Directed IRA Handbook by Mat Sorensen Attorney at Law I suggest these because I have several replies (written) from Attorneys suggesting I try a firm more qualified in the IRA/Solo 401k area after discussions. Each was confident they were the firm for me until we got into specifics and my questions were backed by references. I like Attorneys and CPAs but not because they have the title. As a multi-state investor I’ve had similar situations with CPAs in a new state, but more of a blank stare after the assurance that they were absolutely correct until specifics are discussed.
    Nate
    Replied over 3 years ago
    How does an investment that starts out at $5500, keeps $177/year over 8 years, only end up with $5225 at the end of 8 years?
    Nate
    Replied over 3 years ago
    How does an investment that starts out at $5500, keeps $177/year over 8 years, only end up with $5225 at the end of 8 years?
    Jesse Hargrove Investor from Charlestown, New Hampshire
    Replied over 3 years ago
    I don’t know where you can purchase a home for 27,000.00. I live in the north east and that isn’t happening. I have used my IRA to purchase single family homes. the process is not difficult. I am sure of one thing. I am in control of my IRA . I was in the stock market for many years. I would much rather own a home that I can touch and has a good cash flow than any mutual fund out there. I think the days of double digit returns are gone. I was thrilled when I found out I could use my IRA funds to purchase rental property. It has been working out for me and the cash goes back into my IRA. You need a good team, property manager. you need to purchase quality homes in good areas. that are growing. and for a fair price. This is my retirement plan. I wish I could use my 401 K funds to purchase more.
    Joseph M. from Saint Paul, Minnesota
    Replied over 3 years ago
    It would be pretty difficult to not make money on a $27,000 house that you can rent for $675 a month, IRA or not.
    anagha
    Replied about 3 years ago
    Few pointers – Coverdale Educational Savings Accounts contributions are not tax deductible..The distributions if less than education expense are tax free. also beneficiary should be less than 18 years..Hence, these points are not clearly specified. Also, if I invest my rental income in another rental the snowball will build home equity and returns are much better. IDeally earnings from 60 to 90 years is a myth and does nto happen in most cases owing to aging factor