Buying Real Estate in an IRA. Buying Real Estate in an IRA 6/19/2018. Why Haven t I Heard of This Before? 3hrs CE TREC course 7669

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Bridget Rose
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Buying Real Estate in an IRA 3hrs CE TREC course 7669 IRA Innovations is a third party administrator of Self-directed retirement plans. We do not provide tax, legal or investment advice.

Why Haven t I Heard of This Before? Few people are aware that the IRS allows the use of Self-Directed IRAs to purchase Real Estate.

1 Buying Real Estate in an IRA 3hrs CE TREC course 7669 IRA Innovations is a third party administrator of Self-directed retirement plans. We do not provide tax, legal or investment advice. Any information provided by IRA Innovations is for educational purposes only. Please consult with legal, tax and accounting professionals when making an investment decision. Why Haven t I Heard of This Before? Few people are aware that the IRS allows the use of Self-Directed IRAs to purchase Real Estate. Most brokerages and mutual fund companies are not equipped to deal with the administration of holding individual parcels of Real Estate in an IRA & have a interest in their clients investing in stocks, mutual funds and bonds. They are not in the Real Estate business and may tell you it is not allowed. 1

What Does The IRS Say? IRA trustees are permitted to impose additional restrictions on investments.

IRA law does not prohibit investing in real estate but trustees are not required to offer real estate as an option. http://www.irs.

NO Collectibles or Life Insurance any work of art any rug or antique any metal or gem any stamp or coin any alcoholic beverage *Exception* Gold, silver, or platinum American Eagles or gold, silver,

2 What Does The IRS Say? IRA trustees are permitted to impose additional restrictions on investments. For example, because of administrative burdens, many IRA trustees do not permit IRA owners to invest IRA funds in real estate. IRA law does not prohibit investing in real estate but trustees are not required to offer real estate as an option. IRS Rules and Regulations What Investments Are Allowed? NO Collectibles or Life Insurance any work of art any rug or antique any metal or gem any stamp or coin any alcoholic beverage *Exception* Gold, silver, or platinum American Eagles or gold, silver, platinum, or palladium bullion Possible IRA Investments Real Estate Mortgage Notes Unsecured Loans Tax Lien Certificates Stocks, Bonds, Mutual Funds Extraordinary Investments Security Agreements & Notes Private Placements Certificates of Deposit Tangible Asset Deeds Foreign Sales Corporate Stock Accounts Receivable Financing Precious Metals LPs & LLCs Auto Paper Trust Deeds Like & Unlike Exchanges Contract Options Building Bonds Commercial Paper Commodity & Option Exchanges Commodities / Futures Leases Joint Ventures Factoring 2

3 Rules of The Road There are certain people your IRA can not do business with. Think of your IRA as Mr. IRA There are certain people Mr. IRA can not do business with. IRS Rules and Regulations Examples of Disqualified Persons: You and your spouse Lineal ascendants (and their spouses) Lineal descendants (and their spouses) Any fiduciary of IRA Anyone providing services to your IRA Corporations, partnerships, trusts, or estates in which you or any disqualified person owns, directly or indirectly, at least 50% Or where a disqualified person has 10% ownership or more and is an officer or has officer like duties. 3

NO self dealing 2. NO personal use/benefit to a disqualified person!

4 IRS Rules and Regulations (continued) What Transactions Are Prohibited? Prohibited Transactions: IRC Sec. 4975: An IRA cannot engage in any transaction (direct or indirect) with anybody or anything considered to be a disqualified person to IRA *Two key points with IRAs and real estate: 1. NO self dealing 2. NO personal use/benefit to a disqualified person! IRS Rules and Regulations (continued) Consequences for prohibited transactions Treated as a distribution, may have penalties for early withdraw. Can accrue penaltites for under reporting if not caught early. Participant may have to pay a 15% excise tax or a 100% penalty. IRS Rules and Regulations (continued) Examples of prohibited transactions between a disqualified person and an IRA are: Selling, exchanging or leasing property Lending money or extending credit Furnishing goods, services or facilities Transferring income or assets Using the income or assets for personal gain Use of property personally, by any ascendant, lineal descendant or spouse of a lineal descendant 4

IRS Rules and Regulations (continued) Examples of acceptable transactions: Partnering with yourself on a new deal Partnering with your cousin Partnering

Your daughter lives in Real Estate purchased by your IRA. Allowable? No 3. You personally collect rent for your IRA. Allowable? No 4.

5 IRS Rules and Regulations (continued) Examples of acceptable transactions: Partnering with yourself on a new deal Partnering with your cousin Partnering with your spouse on a new deal Leasing the property to a sibling POP QUIZ!!!! 1. Your IRA Purchases a Rental Property. Allowable? Yes 2. Your daughter lives in Real Estate purchased by your IRA. Allowable? No 3. You personally collect rent for your IRA. Allowable? No 4. You receive commission on a property your Dad s IRA purchases? Allowable? No Case Studies Rental Property Rehab Property Partnering Participation Agreement Becoming A Private Lender Checkbook IRA LLC 5

6 Case Study Rental Property John intends to purchases a rental condo for $200,000 within his SEP - IRA He transfers $225,000 from his brokerage firm to his SEP- IRA to purchase the property. Case Study Rental Property 1. John initiates a contract to purchase the condo under the SEP IRA. ABC IRA company as custodian, FBO John Wood SEP - IRA 2. John completes a Buy Direction Letter (Real Estate) 3. IRA Innovations sends escrow deposit of $5,000 from the SEP-IRA to the title company and coordinates closing. Case Study Rental Property 4. John Reads and Approves all closing documents. 5. ABC IRA company wires the SEP - IRA funds to the title company to close. 6. The Warranty Deed is recorded in the name the SEP IRA and sent to ABC IRA company for safe keeping 6

Case Study Rental Property The SEP IRA is now the owner of record on the warranty deed. ABC IRA company as custodian, FBO John Wood SEP-IRA John decides to hire a property manager.

7 Case Study Rental Property The SEP IRA is now the owner of record on the warranty deed. ABC IRA company as custodian, FBO John Wood SEP-IRA John decides to hire a property manager. Case Study Rental Property John locates a property management company to oversee the unit. 1. The property management company finds a tenant to lease the unit. 2. Rents and expenses are handled by the property manager. 3. Condo has a positive cash flow of $900 tax deferred. John tracks his account via his online statements. Case Study Rental Property Two years later, tenant offers to purchase the property for $275, A sales contract is prepared for $275, John completer a Sell Direction Letter 3. ABC IRA coordinates closing with the title company. 4. On day of closing, John Reads & Approves all closing documents. 5. Proceeds, after closing costs, are wired back into his SEP-IRA. 7

8 Realized Return for each SEP-IRA Initial investment $200,000 Cash flow over 24 months ($900 x 24) $ 21,600 Gains from Sale($275,00 - $200,000) $ 75,000 Balance of SEP- IRA account after sale $296,600 Tax Deferred gain of $96,600 (48%) over 24 months!! Case Study Rehab Sam Smith decides to purchase a Fixer- Upper Case Study Rehab Purchase process is same as before: Contract must be in name of IRA Buy Direction Letter Earnest money comes from IRA Closing documents are signed by custodian (after written approval from IRA holder) Title to property is taken in name of IRA: ABC IRA company as custodian, FBO Sam Smith IRA 8

9 Case Study Rehab Sam selects a contractor to oversee rehab Case Study Rehab All rehab cost must be paid by IRA. They can never be paid by Sam. As a disqualified person, Sam cannot do work on the house. Case Study Rehab Rehab is completed and placed For Sale 9

Case Study Rehab All legal documents must list IRA correctly as seller IRA holder negotiates the sales price but custodian will sign Purchase Agreement as seller.

10 Case Study Rehab All legal documents must list IRA correctly as seller IRA holder negotiates the sales price but custodian will sign Purchase Agreement as seller. Case Study Rehab Goes through a normal closing process Custodian will sign all closing documents on behalf of the IRA (after written approval) Proceeds are sent back directly to the IRA as the seller Tax-Free or Tax Deferred Case Study: Partnering Lisa And Mother Lisa and her mother decide to buy a condo together Price: $300K Mother is 70% owner $210K of her own money Lisa s IRA is 30% owner $90K 10

11 Case Study: Partnering Lisa And Mother Same steps as before Contract (in name of both parties) Buy Direction Letter (Lisa only) Earnest Money (either party) Closing Deed Recorded as Mother as an individual, 70% undivided interest & ABC IRA company as custodian, FBO Lisa s IRA, 30% undivided interest Case Study: Partnering Lisa And Mother Before the deal Mother has no ownership Lisa s IRA has no ownership Because this is a new deal Mother and Lisa do not have to worry about the disqualified person rule Case Study: Partnering Lisa And Mother After the deal The disqualified person rule comes into effect Neither Mother nor Lisa can live in the condo No one who is disqualified to either of them can live in the condo Ascendants, descendants, etc. 11

Case Study: Partnering Lisa And Mother After the deal Neither Mother nor Lisa can ever buy out each other s ownership They are disqualified to each other Expenses and profits are split 70% to Mother

Must be a Non- Recourse loan to the IRA Mortgage is paid by IRA A form of UBIT (unrelated business income tax) may come into play The taxable income is in proportion to % of debt Case Study: Joint

12 Case Study: Partnering Lisa And Mother After the deal Neither Mother nor Lisa can ever buy out each other s ownership They are disqualified to each other Expenses and profits are split 70% to Mother Taxable 30% to Lisa s IRA Tax-deferred Buying using a Mortgage Yes an IRA can obtain a Mortgage The IRA holder cannot personally guarantee the loan. Must be a Non- Recourse loan to the IRA Mortgage is paid by IRA A form of UBIT (unrelated business income tax) may come into play The taxable income is in proportion to % of debt Case Study: Joint Venture/Participation Agreement Willy knows a builder who it always looking for money partners to help fund the large rehab projects that he takes on. The builder has a new project where he has purchased a home in need of repair for $200K Rehab costs are estimated to be $100k. Expected ARV is $360k 12

Case Study: Joint Venture/Participation Agreement (continued) They reach an agreement where Willy will use his IRA to fund the rehab portion

Agreement (continued) They have an attorney prepare the Participation Agreement Willy provides a Buy Direction Letter instructing us to fund

the builder as instructed by Willy Case Study: Joint Venture/Participation Agreement (continued) 4 months later the rehab is complete and the

13 Case Study: Joint Venture/Participation Agreement (continued) They reach an agreement where Willy will use his IRA to fund the rehab portion and they will split the profits 2/3 to the builder & 1/3 to the IRA upon sale of the property Case Study: Joint Venture/Participation Agreement (continued) They have an attorney prepare the Participation Agreement Willy provides a Buy Direction Letter instructing us to fund his new investment Willy will need to provide us his written approval on a copy of the Participation Agreement ABC IRA company sends funds to the builder as instructed by Willy Case Study: Joint Venture/Participation Agreement (continued) 4 months later the rehab is complete and the house sells for $360k as expected At closing, the $60k is split per the terms of the agreement so: Builder receives: $40k Willy s IRA receives: $20k 13

Case Study: Lending to a Rehabber Sue s IRA becomes a lender Sue belongs to her local real estate investment club.

She thinks she would realize a better return if she did private lending from her IRA.

Sue s due diligence on Sam and the property 2. Due diligence costs are paid from her IRA. 3. Sue offers to lend $80,000.

14 Case Study: Lending to a Rehabber Sue s IRA becomes a lender Sue belongs to her local real estate investment club. Sue wants to offer loans to people who buy and fix foreclosures. Sue has an $85,000 IRA. She thinks she would realize a better return if she did private lending from her IRA. Case Study: Lending to a Rehabber (Continued) Sue turns her IRA into a lender Sam the rehabber is looking for a loan: 1. Sue s due diligence on Sam and the property 2. Due diligence costs are paid from her IRA. 3. Sue offers to lend $80,000. Case Study: Lending to a Rehabber (continued) Sue s loan terms Loan amount ~ $80,000 Interest rate ~ 12% 2 points ~ 1 at origination & 1 at payoff Maturity is 2 years from issuance Monthly payment ~ $ First mortgage on the property 14

Case Study: Lending to a Rehabber (continued) The note Sue s attorney prepares the note and mortgage. All documents are sent to ABC IRA company as custodian.

Case Study: Lending to a Rehabber (continued) Loan payoff Six months later: Sam, the rehabber, is ready to sell the property He requests the payoff amount Sue does not

15 Case Study: Lending to a Rehabber (continued) The note Sue s attorney prepares the note and mortgage. All documents are sent to ABC IRA company as custodian. Buy Direction Letter used to fund the note. Case Study: Lending to a Rehabber (continued) Loan payoff Six months later: Sam, the rehabber, is ready to sell the property He requests the payoff amount Sue does not have a loan servicer so Sue calculates the payoff. Payoff letter is sent to the title company handling the close. Case Study: Lending to a Rehabber (continued) Sue s IRA Value Repaid principal ~ $80,000 Payments ~ $4,800 2 points ~ $1,600 Total earnings ~ $6,400 Return on investment ~ $6,400 / $80,000 x 2 16% 15

16 Checkbook Control IRA The IRA forms a LLC and the IRA(s) is named as the member(s) You are named as manager of the LLC but you are not the owner Neither you nor any other disqualified person can receive any compensation. As manager, you have to ensure the LLC does not do business with a disqualified person Items we will need: Buy Direction Letter Copy of Operating Agreement with READ & APPROVED 16

A real estate would be similar to: 1 2 3 The manager of the LLC signs purchase contract for real estate The offer is accepted & LLC places escrow deposit.

Make your yearly contribution Liquidate other assets in the IRA Transfer money from other retirement accounts Bring on a partner (not a disqualified person) IRA can get a loan Sell

17 A real estate would be similar to: The manager of the LLC signs purchase contract for real estate The offer is accepted & LLC places escrow deposit. The manager of the LLC executes the closing documents and wires funds to close. Make your yearly contribution Liquidate other assets in the IRA Transfer money from other retirement accounts Bring on a partner (not a disqualified person) IRA can get a loan Sell the asset Shortage of Funds in IRA Types of Plans That Can Be Self-Directed Traditional IRA Roth IRA SEP SIMPLE IRA Rollover IRA - (Funds from a Qualified Plan, including 401(k), 403(b), 457 plans can be rolled into an IRA) Solo 401(k) Coverdell Education Savings Accounts (CESA) Health Savings Accounts (HSA) 17

18 IRA Contribution Limits Traditional IRA $5500 Age 50 -$6500 Must have earned income deductibility is based on annual income. RMDs required at 70 ½ yrs of age Deductibility dependent on income ROTH IRA $5500 Age 50 -$6500 Must have earned income deductibility is based on annual income. NO RMD Upper income limit on contributing ($120k single - $199k joint) There is a work around if your income is too high. SEP Contribution Limits Simplified Employee Pension 25% of employees compensation up to $54K Set up and contributions made by employer (i.e. no FICA/Medicare) Contributions deadline up to business tax return is filed SIMPLE Contribution Limits Savings Incentive Match Plans for Employees $12,500 ($3000 catch-up age 50 or older) Must be set-up by Oct 1 st of Plan Year Early Withdrawal Penalty of 25% if in first two tears. Employer matching of 1%-3% 18

19 Solo 401(k) Contribution Limits Employee Elective Deferrals up to 100% of compensation $18,500 (+$6000 catch-up at age 50 or over) Employer non-elective contributions: up to: 25% of compensation as defined by the plan Total contributions to a participant s account, not counting catch-up contributions for those age 50 and over, cannot exceed $55,000 for 2018 Question You Should Be Asking! If Yes: DO YOU HAVE A RETIREMENT PLAN? One of my specialties is helping investors build wealth in Real Estate TAX FREE or TAX-DEFFERRED within their retirement account. Follow Up: When can we meet to explore whether or not this strategy would work for you? Mike Todd Business Development Manager IRA Innovations Brentwood, TN phone mike@irainnovations.com 19

REAL ESTATE INVESTING GUIDE. Combine IRA tax advantages with real estate investment opportunities.

REAL ESTATE INVESTING GUIDE. Combine IRA tax advantages with real estate investment opportunities. REAL ESTATE INVESTING GUIDE Combine IRA tax advantages with real estate investment opportunities. INTRODUCTION The IRS allows an IRA, Solo 401(k), or HSA to acquire real estate as an asset without penalty