InvestorLoft Real Estate Investing Blog

Real Estate IRAs - Save Smarter!

The self-directed or real estate IRA is a powerful tool and growing in its popularity. However, as with any other way of investing your retirement funds, it’s not to be taken lightly.

Rental and other income property can be excellent vehicles that provide long-term appreciation potential and a steady flow of income as you work towards retirement. We spoke with Jenn Dizmang, a national speaker and former securities professional who teaches investors and real estate professionals how to properly use a real estate IRA for some advice on common mistakes that people make in the process.

Jenn shared with us that the following are the most common AND the most easily avoidable mistakes she sees people making with their real estate IRAs:

1. They either live in or vacation to the property that their IRA owns
2. They try to let family members use or live in property that the IRA owns
3. They don’t realize that when an IRA takes a loan, an additional tax may be due called UDFI (Unrelated Debt Finance Income Tax)
4. They try to lease the property back to themselves from the IRA
5. They try to do rehab work themselves on a property that is owned by the IRA. (You have to hire a contractor that is an unaffiliated party to perform the work!)

Your Virtual Key to Real Estate Investment

We find so much powerful information across the web on a weekly basis that we wanted to take a moment and fill our readers in on the “coolest of the cool” in this week’s real estate and investment markets.

Back on April 3rd, we posted Real Estate: the Self-Directed Perspective and have found that this subject is really heating-up across the web. Here are two complimentary posts on the subject of “retiring with real estate” that our readers might also find useful:

Real Estate: Market Slowdown Offers Deals for Real Estate Investors – DailyPress.com. Real Estate is on sale and the market’s current slowdown is offering great deals for real estate investors in the Norfolk, VA region. InvestorLoft members can search Virginia for investment property!

Using IRAs to Buy Real Estate: Six Reasons to Tap Retirement Funds Now to Buy Rental Property - (Chris Pummer) MarketWatch.com. There’s a lively discussion going on over at MarketWatch on Chris Pummer’s series of articles on investing in real estate with your retirement funds. This let us know that we’re doing the right thing at InvestorLoft by helping educate our members and site visitors on the details of using their IRAs to purchase real estate. Have you seen our 7-part series on the Basics of Real Estate and Self-Directed IRAs?

Self-directed IRAs can build your nest egg

Many investors have become disenchanted with recent stock market volatility, stories of corporate scandal and corruption. In addition to impacting retirement account values, these events have also strained investor confidence. It is no wonder then that more and more investors are pushing their advisors to offer Self-Directed IRAs (SDIRAs) that allow them to invest in alternative assets which they believe will provide greater diversification and control over their retirement nest eggs.

Factors
While the list of alternative investments includes a wide-ranging group of assets–including private equities, hedge funds and mortgages–one area that has captured the greatest level of interest is real estate.

Typically, real estate comprises 60% of clients alternative asset investments. Some real estate advisors suggest that falling prices combined with increasing inventory is creating new investment opportunities. As prices begin to fall, the pendulum may swing past center to create oversold conditions, providing opportunities to buy real estate at low prices. Some areas in the U.S. may already be starting to experience this phenomenon.

Another factor to consider is that many real estate investors are being squeezed out of the market due to the current credit crisis. This has created a unique opportunity for cash-rich retirement plan investors. These investors are either purchasing the real estate outright, through a partnership, or LLC. It is estimated that the first of more than 78 million baby boomers will begin to retire this year. This group controls more than $14 trillion dollars in retirement plan assets. These assets are being rolled-over from employer-based plans to individual retirement accounts. Many baby boomers have already begun to shift away from traditional equity investments to those that generate income, such as, income-producing property. Add these factors with the possibility of equity appreciation, and it is clear why real estate is growing in popularity.

Opponents of using the SDIRA to invest in real estate focus on key concepts which they believe have a profound effect on individual financial strategies. Before engaging in any transaction prudent investors are wise to consider them. First, profits personally made in real estate, if long-term, are taxed at the capital gains rate of 15%. When a SDIRA sells a piece of real estate there are no taxes due at the time of sale. However, when the owner takes a distribution from their retirement account, the proceeds will either be taxed at their ordinary income rate (for a traditional SDIRA) or are tax-free under the Roth SDIRA.

Additionally, SDIRA investors cannot depreciate property or write off interest from their mortgage on their personal tax return. Another important issue concerns the access and use of property held inside the SDIRA. Neither the account holder nor his or her family members may have personal use of said property; doing so would result in a prohibited transaction. SDIRA firms, such as Trust Administration Services can help educate investors about how to use a self-directed retirement account to invest in alternative investments and other investments.

Taking the First Steps
Any investor that has been intimately involved in a real estate transaction is already familiar with the basic requirements of buying real estate in a SDIRA. There are other issues which must also be considered, such as ensuring the proposed investment is not a prohibited transaction. This is why choosing the right self-directed retirement plan custodian is important. Important factors to consider when selecting a self-directed IRA custodian include experience, a consistent service record, organizational structure and wealth o expertise.

After the proper SDIRA custodian has been selected, the investor should request and complete the appropriate forms for their Traditional, Roth, SEP, Simple, Individual 401(k) or other qualified plan(s). The SDIRA advisor will guide the individual through this process.  Once the account is established, the SDIRA custodian will forward the transfer form to the resigning custodian, whether that is a brokerage firm, mutual fund, insurance company, bank or trust company. Upon receipt the prior custodian will transfer the assets to the new SDIRA. A high-quality SDIRA advisor will make the process seamless for investors.

Cost
The fees associated with maintaining a SDIRA vary among firms and is one of the most important distinguishing factors. Most SDIRA firms choose to charge based on a percentage of assets, while a minority employ a transaction-based fee schedule, which is typically kinder to larger retirement accounts. When considering alternative investments, which have longer time horizons with potentially higher returns, the percentage of assets fee approach may not be as beneficial to the SDIRA account owner. Consequently, each account holder should consider his or her specific situation before determining which is best.

Summary
Ongoing market volatility, combined with the need of baby boomers to generate income, and retire securely, is causing investors of all shapes and sizes to take a hard look at their investment allocations to ensure there is a proper mix of opportunity and risk. As investors needs change, alternative assets and self-directed retirement accounts will become important tools to diversify and grow retirement wealth.

TommyJoe A. Valenzuela is Vice President of Sales and Marketing for TAS (Trust Administration Services), a division of First Regional Bank and online at www.trustlynk.com. He has over fifteen years experience in the financial services industry. He is a guest speaker at industry conferences, addressing topics such as taxable investment strategies and retirement plan investing.

The content in this blog is not affiliated with nor is it endorsed by InvestorLoft.com and contributors receive no compensation for submitted articles. All articles submitted to InvestorLoft are subject to editorial review. Please seek the advice of qualified real estate, tax and financial professionals before investing in any project or opportunity. InvestorLoft does not provide tax or legal advice and any and all content herein is provided for informational and educational purposes only.