Buying Real Estate in Your IRA

1.  Who is H. Quincy Long and why do I care?

H. Quincy Long, who holds the designation of CISP (Certified IRA Services Professional), is CEO/President of Quest Trust Company, Inc., a self-directed IRA third party administrator with offices in Houston, Dallas, and Austin, Texas as well as Mason, Michigan.  Mr. Long has been a licensed Texas attorney since 1991 who specializes in real estate, and has been a fee attorney for American Title Company.  He has sat on the board of directors of the Realty Investment Club of Houston (RICH), the second largest real estate club in the country.  Mr. Long received his Doctor of Jurisprudence law degree in 1990 from the University of Houston.  He received his Master of Laws, also from the University of Houston, in 1997.

Mr. Long is also the author of numerous articles on self-directed IRAs and other real estate related topics, and is editor and co-author of the book Real Estate Investment Using Self-Directed IRAs and Other Retirement Plans by Dyches Boddiford and George Yeiter, CPA.

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Mr. Long knows real estate and real estate investing. This can be critical to you when choosing a self-directed IRA custodian or administrator, especially if you want to buy real estate or real estate related products in your IRA.

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2.         What does Quest Trust Company, Inc. do?

Quest Trust Company, Inc. (www.QuestIRA.com) is a third party administrator of self-directed IRAs in Houston, Dallas, and Austin,Texas, as well as Mason, Michigan. Quest Trust Company, Inc. is the leading provider of self-directed retirement account administration services.  Quest Trust Company has been in business since 2003 with over $400MM in assets under management.  As a neutral party, Quest Trust Company does not offer any investments and therefore has no conflicts of interest with what our clients want to do with their IRAs.  Quest allows you to be in total control of your retirement wealth.

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3.         As a real estate professional, how can knowledge about self-directed IRAs put money in my pocket now?

For those of you who are investors, you can make other people aware that they actually have more money to invest in real estate than they thought since they can use their IRAs to buy real estate.  In other words, your knowledge of self-directed IRAs can increase your pool of eligible buyers for your properties.  Also, you can help others transfer their retirement funds into a self-directed IRA, then you can borrow those funds to make your own investments – in other words, you can create your own private bank!  Finally, you can make your own retirement wealth grow with your knowledge and experience in real estate by buying and selling through your own self-directed IRA.

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4.         What is the difference between a “self-directed IRA” and a regular IRA?

There is no legal distinction between a “self-directed IRA” and any other IRA.  The difference is simply this:  Quest lets you take control of your retirement by letting you invest your IRA in what you know best.  There are 2 different sets of rules that govern what you can do with your IRA.  First, there is the Internal Revenue Code, which has surprisingly few restrictions.  Second, there is your account agreement with the custodian.  With most custodians you are restricted in the type of investments you can buy in your IRA.  Quest allows you the maximum amount of control and flexibility.  Almost anything that can be documented can be held in your Quest self-directed IRA.

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5.         Which types of IRAs does Quest Trust Company offer?

  • Quest offers almost all types of retirement plans, including:
  • Traditional IRAs
  • Roth IRAs
  • SEP IRAs
  • SIMPLE IRAs
  • Individual 401(k)s, including the NEW Roth 401(k)
  • Coverdell Education Savings Accounts (formerly Education IRAs)
  • Health Savings Accounts (HSAs)

All of our plans are self-directed, and all of them can hold the same type of non-traditional assets, such as real estate.

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6.         How much can I contribute to my IRA?

Roth and Traditional IRAs –   $4,000 for 2007 (increased to $5,000 for 2008) plus $1,000 catch-up if you are age 50 or over by the end of the year.

SEP IRAs – 25% of your wages (or up to 20% of your net earnings from self-employment) up to a maximum of $45,000 for 2007 and $46,000 for 2008.  Contributions can be made up to the employer’s tax filing deadline, including extensions (if you are self-employed, you are the employer).

SIMPLE IRAs – $10,500 salary deferral plus $2,500 catch-up if you are 50 or over for 2008 plus up to 3% of your salary matched by your employer.

Profit Sharing/401(k)s – $15,500 in salary deferral for 2007 and 2008, plus catch-up deferral of $5,000 if you are age 50 or older by the end of the year plus 25% of your wages (or 20% of your net earnings from self-employment) up to a maximum of $45,000 for 2007 and $46,000 for 2008 (excluding the catch up contribution of $5,000).

Coverdell ESAs (formerly Education IRAs) – $2,000 per year until the child is age 18.

Health Savings Accounts (HSAs) – $2,850 for individual coverage in 2007 ($2,900 for 2008) and $5,650 for family coverage in 2007 ($5,800 for 2008) plus $800 catch-up for 2007 ($900 for 2008) if you are over age 55.

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7.         What kinds of investments can be made in an Quest Trust Company self-directed IRA?

  • You have the broadest possible choice of investments, including:
  • Real Estate, including debt-financed and foreign real estate
  • Deeds of Trust
  • Real Estate Options
  • Lease Options
  • Unsecured Notes
  • Oil and Gas Interests
  • Small, non-publicly traded corporate stock
  • Limited Liability Companies
  • Limited Partnerships
  • Factored Invoices
  • Discounted Commissions
  • Security Agreements and Notes
  • Tax Lien Certificates
  • Foreclosure Property
  • Joint Ventures
  • Race Horses
  • Publicly traded stocks and mutual funds
  • and a whole lot more…

It should be made clear that you are not taking a distribution to purchase these assets.  All assets are purchased within the IRA, and all profits stay in the IRA!

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8.         Is it really legal to buy real estate in your IRA?

Yes, absolutely!  The Internal Revenue Code does not tell you what you can do with your IRA, only what you cannot do.  Besides restrictions on purchasing life insurance and most collectibles in your IRA, nearly everything else is fair game.  Unless your IRA is self-directed, however, your custodian may not allow investments in real estate.

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9.         Can I partner with my IRA or with other peoples IRAs?

Your IRA can always partner with other people individually or with other people’s IRAs.  Under certain circumstances you personally may be able to partner with your IRA.  However, the burden of proving that you received no impermissible benefit from your IRA’s participation in the investment will be on you if the IRS ever questions the transaction.  The transaction still must be an arms-length transaction, and the investment remains subject to the same restrictions as if the entire investment were in your IRA.  In general it is better to separate your IRA’s investments from your own investments.

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10.       I only have a small IRA.  How can I buy real estate?

There are at least 4 ways you can participate in real estate investment even with a small IRA.  First, you can wholesale property.  You simply put the contract in the name of your IRA instead of your name.  The earnest money comes from the IRA.  When you assign the contract, the assignment fee goes back into your IRA.  If using a Roth IRA, this profit is tax-free forever!  Second, you can purchase an option on real estate, which then can be either exercised, assigned to a third party, or canceled for a fee.  Third, you can purchase property in your IRA subject to existing financing or with a non-recourse loan from a bank, a hard money lender, a financial friend or a motivated seller.  Profits from debt-financed property in your IRA may incur unrelated business income tax (UBIT), however.  Finally, as mentioned above, your IRA can be a partner with other IRA or non-IRA investors.

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11.       Can an IRA buy debt-financed property?

Yes.  Any debt must be non-recourse to the IRA and to any disqualified person.  An IRA may have to pay UBIT on its profits from debt-financed property.  In general, taxes must be paid on profits from an IRA-owned property that is debt-financed, including profits from the sale or disposition of the property, in the same proportion that it had debt.  For a simplified example, if the IRA puts 50% down, then 50% of its profits above $1,000 will be taxable.  Although at first this sounds terrible, in fact leverage can be an extremely powerful tool in building your retirement wealth.  The same leverage principle applies inside or outside of your IRA.  You can do more with debt-financing than you can without it.

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12.       Could my IRA be classified as a “dealer?”

It is possible that an IRA could be classified as a dealer.  The same principles for determining whether you are a dealer personally also apply to your IRA.  If the IRA is classified as a dealer, it would be considered to be running an unrelated trade or business, and the IRA would have to pay UBIT.  Remember, it is not illegal to do things in your IRA that incur UBIT.  Your IRA just has to pay taxes.

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13.       Can I sell a property I now own to my IRA?

No.  Although the IRS has very few restrictions on the types of investments which are permissible in an IRA, there is a list of “disqualified persons” who are prohibited from dealing with your IRA or benefiting from its investments.  The list of disqualified persons includes you, your spouse, your parents, your children, their spouses, certain business partners and key employees and persons providing services to your plan, among others.  Interestingly enough, the definition of disqualified persons does NOT INCLUDE non-lineal descendants or ascendants, so if the transaction is an arms length transaction your IRA may be able to transact business with your brother or sister, aunt or uncle, cousins, etc.  However, you should be aware that there is an element of danger in transacting business with any person in whom you may have an interest which affects your best judgment as a fiduciary of your IRA, as this could be considered to be a prohibited transaction.

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14.       Can I receive a fee for managing property owned by my IRA?

No.  The prohibited transaction rules are intended to make sure that you receive no current benefit from your IRA other than as the beneficiary of the IRA.  Investments must be arms-length and exclusively for the benefit of your IRA.

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15.       If I am a Realtor, can I receive a commission for property bought or sold by my IRA?

No, for the same reasons stated in the prior answer.  Anything that creates a possible conflict of interest with your IRA is likely to be a prohibited transaction.  Why take money that is tax-free or tax-deferred and pay taxes on it now anyway?

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16.       Can I collect rents and do other management without compensation?

Most likely the answer is yes, although this has never been tested in court to our knowledge.  An interesting question is how much can you do before your service to your IRA constitutes an excess contribution?  In any event all checks must be made out directly to your IRA.

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17.       I like the sound of this, but can you give me specific, real life examples of what has been done in an Quest self-directed IRA?

Example 1 – Wise Roth Conversion.  Dapper Don has two Quest Trust Company self-directed IRAs a traditional IRA with money from his former employer’s retirement plan and a Roth IRA.  Don found a small piece of property in the country with a mobile home on it, which he could acquire for about $12,000. Don realizes the high profit potential of this transaction, but has insufficient funds in his Roth IRA to do the deal. Because Don will have modified adjusted gross income of less than $100,000 this year, he decided to convert $12,000 from his traditional IRA into his Roth IRA. Only seven weeks after his Roth IRA purchased the property, it was sold to the neighbor for $30,000. Although Don must pay income taxes on the $12,000 he converted from his traditional IRA to his Roth IRA, the $18,000 in profit from the transaction is TAX-FREE FOREVER!

Example 2 – Note Secured by Real Estate.  Savvy Sam borrows money from Rich Rodney’s IRA at Quest Trust Company.  Sam agrees to pay Rodney’s IRA 15% interest with no points and a 3 month minimum term on the loan.  Before Sam can even finish the repairs, he gets an offer on the house.  Sam accepts the offer, and they close within 6 weeks.  Sam is ecstatic because he made $20,000 with no money from his pocket.  Rich Rodney is very happy too because Sam paid his IRA 90 days of interest at 15% and only kept the money outstanding for 6 weeks!

Example 3 – Rehabbing a House.  Rehabber Rhonda buys a house needing substantial repairs for $101,000 cash in her Quest Trust Company.  Rhonda spends approximately $30,000 from her IRA on the rehab.  The property is sold in 6 months for $239,000.  After the cost of the purchase, rehab, closing costs, holding costs and selling costs, Rhonda’s IRA nets approximately $94,000 on the deal.

Example 4 – Co-Investing With an IRA.  Wise Wally invests $5,000 from his SEP IRA at Quest Trust Company and Wally’s father invests an additional $5,000 on a house purchased for $10,000 cash.  Although the house could be called a junker, the rental income is $400 per month, which of course is split equally between Wally’s IRA and Wally’s father (the tenants send separate checks).  Wally believes that eventually this neighborhood will be bought up by developers because of its location right on the lake.  In the meantime, Wally expects to recover his acquisition expenses from the rental income in less than 3 years, even after payment of property taxes.

Example 5 – Purchase and Simultaneous Resale of Real Estate.  QuickQuincy finds a commercial piece of land and puts it under contract in his Roth IRA for $500,000. Quincy’s IRA pays the earnest money. Quincy then contacts a major home improvement chain about buying the land.  After some negotiation, the store chain and Quincy’s IRA agree to a sales price of $650,000.  At closing,Quincy’s IRA buys the property from the seller and simultaneously sells the property to Barry’s retail store chain. Quincy’s Roth IRA nets approximately $146,000 after payment of closing costs.

Example 6 – Assignment of a Contract.  Awesome Annie gets a contract on a burned out house in the Coverdell ESA of her daughter, Smart Sally, for $5,500 cash with a $100 earnest money deposit.  Annie locates Investor Ingrid, who is willing to pay $14,000 for the house.  Sally’s Coverdell ESA assigns the contract to Ingrid, and at closing Sally’s Coverdell ESA gets a check for $8,500.

Example 7 – Buying Real Estate With a Loan.  Realtor Rose is a full-time real estate agent who at times purchases rental real estate for her own investment portfolio.  Rose locates 2 properties that she wants to buy in her SEP IRA at Quest Trust Company.  The houses Rose wants to buy cost about $210,000.  Rose has a good relationship with a local bank, and they are willing to loan Rose’s IRA the money she needs with only 10% down on a 5 year, 6.5% interest, non-recourse note.

Example 8 – Buying Property Subject to a Lien.  FantasticFlorence finds a property which is subject to nearly $100,000 in delinquent property taxes and is about to be foreclosed on by the taxing authorities.  She contacts the owner and buys the property in her Roth IRA at Quest Trust Company for around $3,000 (including closing costs).  The owner just wants to be rid of the headache. Florence’s IRA sells the property to an investor 3 1/2 months later and her IRA nets approximately $46,500 from the sale. Florence’s IRA will have to pay Unrelated Business Income Tax (UBIT) of about $13,500, but even after payment of taxes her IRA will be worth around $33,000 in only 3 1/2 months!

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18.       How can I find out more?

a)      Visit our website at www.QuestIRA.com.  The website has a real estate tour showing you step by step how to buy and sell real estate in your IRA.

b)      Call us at 281-492-3434 or toll-free 800-320-5950.

c)      Email Quincy Long at Quincy@QuestTrust.com.

d)     Sign up for our IRA and 401(k) Insights quarterly email newsletter.

e)      Plan on attending our next 8-hour or 3-hour MCE seminar and learn all about self-directed IRAs.