Analyzing Different Real Estate Strategies for Self-Directed IRAs with Guest Speaker: Shenoah Grove

Estimated reading time: 12 minutes

Self-Directed IRAs are perfect vehicles for creating tax-advantaged buckets of wealth for the future, and they also let investors save for their retirement by investing into assets that they are familiar with and enjoy. Today, Shenoah Grove of the Texas Real Estate Investor Association joins me to share some strategies that have worked for her and her team as she has grown up in the investing world. 

Sarah: Thank you for joining me today. We’re going to talk a little bit about Self-Directed IRA real estate strategies. We’ll also discuss some of the strategies that you are personally using and teaching in your practices. Before we jump in, can you tell me a little bit about yourself?

Shenoah: Yeah, so Shenoah Grove here, founder, owner and operator of Texas REIAs, Texas’ largest association of real estate investor groups with over 87,000 members. I’ve been investing since 2003, but I’m a fourth generation Texas real estate investor. My great-grandparents owned a rental property. They owned about 18. And my grandparents own rental property. My parents still own about 12 doors to this day. So, it’s a little bit in my blood. I love what I get to do every day, both as an investor, as well as the owner and founder of Texas REIAs. I also coach many clients who are looking to either get started in real estate and/or tweak what they’ve already been doing in order to scale their business. So, that’s a little bit about me.

Sarah: It’s really neat that real estate investing has been in your blood for so long. It sounds like it’s something you’ve been passionate about for quite a while. What really got you started? What kick-started your time investing?

Shenoah: Well, I think we have all been socialized, probably over the last 50 years, just to go to college and we’re told that will be how we excel. That’s how we succeed. And even with real estate investing and with generations of real estate investors in my blood, I was also socialized that way. So, I got my undergraduate degree at University of Texas. Then, I got my MBA at Rice and I thought, “This is how I’m going to make it in the world, and how I’m going to make it in corporate America”. As I was doing that, I was working my butt off and I was watching my income grow, but I was also watching my parent’s income. It was double. Their wealth would double just from real estate investing. It became obvious at some point that I needed to reevaluate what I was doing and look at real estate investing in more detail.

Sarah: I love that background. Any specifics that stick out to you?

Shenoah: The first investment deal that I did was actually when I was in college. Now, don’t think that I’m bragging here, but at the time I was making $4.75 an hour. Okay, yeah. How does a college kid with hardly any income buy a house, right? So, the way that we did it at the time – this loan product is not available anymore – but at the time we used something called a “non-qualifying assumable loan”, which is essentially like buying subject-to today. Although they don’t make non-qualifying assumable loans anymore, you can still purchase the property subject-to the existing mortgage today, which is how I got my first house when I was in college. Actually, one of the members of our real estate investors association built a house right next door to this property and sold it for over $2 million. So, that’s how you build wealth as a real estate investor. You buy in the right places and you hold in the right places. And I love what I do now as an investor.

Sarah: Oh yes, I can always see how passionate you are about it every time I’m at one of the Texas REIA events. I always see a smile on your face and it always seems like people really love being a part of the program. Now, there were a couple of terms that you threw out when you were talking. You mentioned subject-to and buy and hold. Those are obviously a couple of real estate strategies that people can utilize whenever they want to invest in real estate. What are some real estate strategies that you’re using right now as you invest?

Shenoah: For me, I want to make money every time the phone rings and we are what we call ourselves, “strategy agnostic”. I don’t care what strategy it is. If there’s an opportunity to make money, then I’m going to employ that strategy. I want to make money whenever the phone rings. I see a lot of investors get caught in the trap of, “I want to do fix and flips”, or “I want to do buy and holds”, or “I want to do wholesaling.” Well, that may work, but it may not work on the next call you’re about to get. So, I don’t care if it’s commercial, single family, a duplex, three-plex, four-plex, or raw land. If there’s an opportunity, I’m going to do my due diligence and try and figure it out.

Sarah: That’s such an important point. There are so many opportunities. 

Shenoah: Right. And you spend a lot of money as a real estate investor on marketing, right? So, if you’re trying to fit every single lead that you get into one specific square, if you will, that’s not going to always work. You’re not going to be able to scale your business and/or reach the amount of income and wealth knowledge that you want as a real estate investor. For me, I love all the strategies. We love to buy, fix and flip. We love to build new. We love to buy and hold. We joke that we have the Blue Bell Ice Cream investing philosophy, being from Texas. Most people know Blue Bell slogans, which is “We eat all we can and we sell the rest.” So, for me, I want to keep all that I can, and I want to sell the rest, meaning sell enough just to fund my lifestyle.

Sarah: And one strategy I know you utilize is the power of the Self-Directed IRA.

Shenoah: Of course, you know, being able to do that in a self-directed IRA, being able to do that in our Roth IRA really increases and even doubles the power of your investing. So, and there’s so many different strategies you can use. In our self-directed IRAs, we loan money to other investors. We also buy properties that we keep as rental properties. We have shares in apartment complexes, multifamily, and other commercial investments. We even buy subject-to the existing loans in our self-directed IRA. And when you think about buying subject-to in your self-directed IRA, for example, that really compounds it. Einstein says the most powerful force in the universe is compound interest or appreciation, right? Combine that with some of the tax-free savings that you can get using a self-directed IRA, specifically a Roth IRA, and there you go.  The self-directed IRA knowledge [is] critical in order to build that tax-free wealth.

Sarah: That’s great. Everyone is a little different. I like to use my Roth to be passive and do private lending, and I always love hearing about the creative ways other’s use their IRAs. 

Shenoah: We also partner with homeowners to do equity partnering. We like auctions and options, wraps, and all sorts of different things. And again, when I see a deal, I don’t look at the deal and say, “I want to fit in my strategy on that deal,” But instead I say, “What does this deal tell me?” It will tell me the strategy that I need to use. That’s a little bit about some of the different strategies that we use, at least in our self-directed IRA. 


Sarah: Absolutely. You talked about a lot of great strategies there and using a self-directed IRA to do so. Before we move on, for those that may not know, can you briefly define what a sub-to is/what a wrap is?

Shenoah: Yes, this is the strategy that will allow your “dollar to holler”, as I like to say. The average price in Texas right now is around $350,000. Not everybody has that money just laying around to be able to do investments with, but they might have $50,000 or $100,000. Well, with $50k or $100k, you could easily reinstate a property and/or do repairs. Even though you couldn’t acquire that property on your own with your own cash or with your own credit, or even on time for example, buying subject-to allows you to cut that timeframe down to nothing versus waiting on a traditional lender that might take 30 to 45 days to give a loan. Sometimes the properties we’re investing in, you don’t have 30 t0 45 days to close it. You might have two or three, and that’s where the excitement and the opportunity comes in. So, you could easily just reinstate a homeowner’s or seller’s loan and take over their payments, right? There’s three instruments that are typically filed on a sale. There’s the general warranty deed (who owns the property), there’s the promissory note (what’s owed on the property), and then there’s the deed of trust, which helps enforce that promissory note and allows for nonjudicial foreclosure, for example, here in the state of Texas. When you’re buying a property subject-to, that original promissory note and that original deed of trust that’s held by the lender stay in place. The general warranty deed transfers to you, the investor. You are the new owner. That’s buying straight subject-to. Now, the best way to do it to make sure you not only protect yourself as an investor, but also the underlying seller, is to create a new promissory note and a new deed of trust. It kind of sits on top of, or “wraps” around, the original note and deed of trust. Then, the original note and deed of trust, (the person you’re making payments to – the person who can foreclose) is the Wells Fargo chase bank of America, et cetera. And the new note is going to be the original seller. So, if you default as an investor on that loan, then the seller can go back and foreclose on you. It gives the seller additional protections that gives the seller a sigh of relief.

Sarah: That was a great explanation. Thank you!

Shenoah: Yeah, so, buying subject-to is really just taking over payments. Creating that wrap around mortgage is where you give that seller those extra protections by creating that additional note and deed of trust. Very powerful strategy again. Then add a self-directed IRA in the mix, and the possibilities of what you can do are endless when you are strategy stacking. It just feels like you’re a Jedi!

Sarah: Oh, I love what you just said there: strategy stacking. That’s a cool term, and self-directed IRAs are obviously just one more layer that you can have as a partner or, you know, a tool in your tool belt. Let’s talk a little bit more about self-directed IRAs specifically. When did you start using self-directed IRAs as a part of your strategies?

Shenoah: When we started investing in 2003, we were in corporate America. We had a 401k and it’s like you had four options: low risk, medium risk, high risk, and international, which means we don’t even know what’s going to happen here. That was about it. So, we started investing, but we kept thinking how we wanted to be diversified. We were going to keep our 401k money in the stock market, and then we we’re going to keep our real estate money over separate. That worked for a while, but at one point we realized we weren’t watching the stock market. We weren’t being good caretakers of that. We also realized that we were probably not going to outsmart the average person who is on Wall Street. But as we started investing for a while, I started to think, “Okay, well, I can outsmart the average real estate investor. So, when we realized that we live, breathe, eat… and sleep real estate, we moved our money over into a self-directed IRA. It’s nice to be able to touch, look, see, and evaluate the investment. You don’t have to worry about some crazy worldwide disruption changing the whole value of the portfolio. 

Sarah: That is so true. 

Shenoah: The only hockey quote that I know is by Wayne Gretzky. And he says, “I don’t skate to where the puck is. I skate to where the puck is going to be.” You need to know where the values are growing and you need to invest in those locations, especially for the buy-and-hold strategy. The fix-and-flips are not going to change value in the short amount of time that you have to raise the value of that property. If you know where the value is going and growing over the course of the next several years and you’re investing there, then you’re going to win. Never is that hockey statement so true then about real estate and real estate investing, specifically when it comes to buying and holding. So, yes, this is something that we’ve loved to do and something that has benefited us, and it has really been the basis for our wealth as investors. And then double that with some of the tax-free benefits that you get, and yeah, it’s called winning!

Sarah: That’s actually exactly what I was going to say, too. Tax fee, and then also being able to invest in what you know. If you’re investing in what love, you’re probably going to get higher returns. Now, on the flip side, are there any strategies that you all try to avoid? Strategies that make you think, “We are going to avoid these at all costs. They don’t work for us.”?


Shenoah: Yeah, every area is different. So, Texas has different laws than California, than Florida, then other places. We factor that into our strategy. And also, as an entrepreneur, you always have to remember that it’s your job to be looking for disruptions, right. What’s the disruption, what is the solution, what is the workaround, and do we need to change our business and look for different strategies. 

Sarah: I love that you mentioned workarounds. I mean, one of the biggest workarounds we have is obviously the backdoor Roth IRA which we talk about in other articles, but some of those work arounds can sometimes even make a strategy you didn’t think you had possible. Those work arounds – when you understand them and do them correctly – they’re so important.

Shenoah: Yes, you have to be careful. I don’t like pushing the envelope when it comes to self-directed IRA specifically from the standpoint of when what I’m doing might create a taxable event for me. I see a lot of people out there who are possibly creating taxable events, just because they don’t know or just because they got educated on what I call “YouTube University”. They’re listening to the wrong people. That’s why I love you guys.

Sarah: Thank you, and you are so right. It really is important to surround yourself with the right people when it comes to proper education, whether it’s Self-Directed IRAs or real estate investing or anything really! Well, Shenoah, I really appreciate you being here with me today and sharing some of your strategies and insights with me today. If people want to get in contact with you where can they go?

Shenoah: Our website for the TEXAS Real Estate Investor Association is https://texasreias.com/ . Thank you!

As you can see, not one strategy is better than the other, but they can all benefit you in some way. Being able to understand and utilize all sorts of different strategies will expand your investing knowledge and could be what takes your Self-Directed IRA to the next level. If you ever have questions about how to utilize certain real estate strategies in your IRA or want more information about how to get started, we encourage you to talk to an IRA Specialist! To learn more about how to get started investing with a self-directed IRA, schedule a 1-on-1 consultation with an IRA Specialist by clicking HERE.

Understanding How to Buy and Sell Real Estate in a Self-Directed IRA

Estimated reading time: 4 minutes

Times are changing. The way many Americans have been taught to invest just doesn’t work anymore. With the unpredictability of traditional investing, more people have been turning to tangible assets like real estate.  Real estate investing allows people to diversify their retirement portfolios without having to deal with the uncertainty of the stock market. Being able to diversify your portfolio with tangible assets is a great way give yourself some added financial security in the future, no matter what the markets may look like. 

Real Estate in an IRA

Buying real estate in a self-directed IRA only requires a few steps. Locating the investment of your choosing is the first step. Since these accounts are self-directed, you are responsible for finding the deal. As you are looking for the perfect deal, remember to do the proper due diligence on your investment. Due diligence is extremely important to ensure you are protecting your investment as much as possible.

After finding the property you would like your self-directed IRA to purchase, you will submit investment documents and work with your self-directed IRA custodian to get your deal funded. When using a self-directed IRA to invest in real estate, it is important to understand that the self-directed IRA is the one making the actual purchase.   Although you are the one directing the IRA, the IRA itself will be the purchaser. Once all documents are signed, the funds will be sent by your custodian in the name of your IRA. 

Process of Purchasing a Real Estate Asset

Real Estate purchases with funds from a self-directed IRA differ slightly from your personal funds. Self-Directed IRAs require you to draw up the offer/contract in the name of the self-directed IRA. For example, when a Quest account is the buyer, the vesting will read: Quest Trust Company FBO [CLIENT’S FULL NAME] [IRA] # [ACCOUNT NUMBER]. Making sure the vesting is correct to show that the purchaser is the IRA will help you to protect your investment. Since your Quest IRA account is the buyer, when listing the buyer’s address on any investment documents, you would use the custodian’s address as well. 

Along with drafting up required documents, many times custodians will have their own internal forms that will need to be completed to purchase the investment, too. These forms allow the client to sign off, giving their approval for funding. After all of the documents are signed, the custodian will work with the third parties to close your real estate asset. Remember: the custodian is the legal entity in administration of your IRA, so the client will not have to attend any closings. 

Holding Real Estate in your IRA

Real estate assets in a self-directed IRA come with some responsibilities. You will want to know what to do when you are faced with property taxes or maintenance. We’ve already discussed how important it is to understand that your IRA owns the investment. In the event taxes are due or a repair is needed, the self-directed IRA will be the one that will need to pay for any expenses that are incurred. When paying for an expense, the custodian will usually require a copy of the invoice/purchase order along with a Payment Authorization Form. 

Similar to the self-directed IRA expenses, all profits and earnings must go back into your IRA. These payments must be made payable to your self-directed IRA and should NOT be deposited into your personal banking accounts. Paying for any expenses with personal money or accepting earnings back to a personal checking or savings account would be a prohibited transaction. You can learn more about prohibited transactions HERE. 

Selling Your Real Estate Investment

When you are ready to sell your real estate investment, you will also make sure to work with your custodian. All required forms will need to be completed so that the self-directed IRA can sell the property. Internal forms are typically required here, as well, along with the contract, warranty deed and final settlement statement showing details of the sale. Once completed, all profits will return to the IRA account. From here, you can continue to invest and grow your self-directed IRA for years to come. 

Investing in real estate with a self-directed IRA can be very lucrative when done correctly. Once you understand the steps to purchase property, starting is as simple as calling up a certified IRA specialist to get started. To learn more about how to get started investing with a self-directed IRA, schedule a 1-on-1 consultation with an IRA Specialist by clicking HERE.

The Best Alternative Investments That You’ve Never Heard Of

Estimated reading time: 3 minutes

After years of diminishing returns on the stock market, more and more financially savvy people are looking towards alternative investments. But what are alternative investments?

Strictly speaking, these are any investment assets which fall outside of the scope of “traditional” investments such as stocks and bonds. They benefit from being less restricted, allowing investors to choose what, when, and how they invest.

By 2023, it is estimated that the alternative investments market will hit a whopping $14 trillion in size, as more and more people seek to avoid the restraints and disappointing returns of conventional investments.

If you’re looking to invest outside the box, here is a list of alternative investments that you absolutely need to consider in 2020. 

1. Venture Capital 

One of the most popular options for alternative investment funds in 2020 is venture capital or VC. This is essentially when you use your money to invest in a growing company that has long-term potential.

By providing venture capital to a company, you stand to profit from the future growth of that company. This is why Silicon Valley is the world’s epicenter for VC funding, owing to the high number of “unicorn” startups that are based there. 

2. Real Estate

By some measures, real estate is the most popular asset class in the world. In times of market turmoil, real estate has historically proven to be a sound investment. With the right knowledge of high-growth real estate markets, you could yield considerable returns by investing in real estate.

To do so, you could switch out your traditional IRA with a Self-Directed IRA, which removes the restrictions placed on traditional IRAs to allow you to invest in real estate for your retirement. Alternative real estate investment comes in all shapes and sizes, so do your research before committing. 

3. Commodities 

The commodities market is vast and incredibly diverse. This means that you should always consult commodities experts before you consider dipping your toe into this oftentimes volatile market.

Popular commodities include oil, gold, coffee, and steel, and are usually traded on futures markets. If you play your cards right and open a commodities contract at the right time, you could make a substantial profit. 

4. Private Equity 

Private equity is a cornerstone of alternative investment management. In a nutshell, this involves investing in companies that are not publicly traded. This is usually about playing the long game, as you will have to wait for the private equity fund you have invested in to sell your holdings, either as part of an IPO or as a merger or takeover. This can easily take several years, but the returns can be substantial. 

Self-Directed IRA: A Vehicle for Alternative Investments 

No matter what kind of alternative investments appeal to you, it is important to have access to the funding vehicles that actually allow you to make those investments. One effective way to do this is with a self-directed IRA.

Traditional IRAs have strict limitations on how the money in it can be invested. However, a self-directed IRA gives you the power to control how you invest in your future. To learn more about how to get started investing with a self-directed IRA, schedule a 1-on-1 consultation with an IRA Specialist by clicking HERE.

Buying Real Estate in an IRA: Understanding Why and How

Estimated reading time: 5 minutes

As Americans have become more interested and involved in their retirement options, Self-Directed IRAs and the opportunity to invest in non-traditional assets have been gaining popularity. One of the more common alternative investment opportunities inside of a Self-Directed IRA are Real Estate assets. 

Many people are looking to diversify their retirement portfolios with tangible assets like Real Estate, after dealing with the often uncertain public stock market. With Self-Directed IRAs, you have the option to invest in all sorts of Real Estate assets such as single-family homes, multifamily and commercial properties, mobile homes, land, and so much more.

Real Estate in an IRA

Holding Real Estate assets in your Self-Directed IRA has many benefits. Many investors enjoy the freedom and security that comes with knowing all of your ‘nest eggs’ so to speak, are not sitting in one basket. Diversifying your portfolio with tangible and non-tangible assets is a great way to give yourself financial security, no matter what the markets may look like in the future. 

Self-Directed IRAs also allow you to hold assets with notably high returns on investments. Real Estate investments have been shown to produce results that are double and sometimes even triple the original price. When these transactions are done inside of an IRA– a tax-exempt vehicle– investors have the potential to grow their Self-Directed IRAs to the millions. 

When you’re ready to start investing in Real Estate in your IRA, it is important to read up on the structuring rules and limitations of the IRS, in order to protect yourself and your investments. For example, when doing a Real Estate investment in a Self-Directed IRA, many people assume that an LLC or other 3rd party entity is needed, in addition to the IRA. While this method makes sense for some investors, it is often not the simplest way to structure a deal. 

First, know that an IRA has the ability to purchase an investment outright– there is no need for a middle entity. Second, if an intermediary entity is created, you will need to be aware of disqualified parties to your IRA.  The term “disqualified parties” refers to those individuals that the IRS has said cannot benefit from or enter into transactions with your IRA. 

For more information on how to keep your IRA working for you and protecting your retirement, visit IRS.gov, and check out the many educational resources available to you at questtrustcompany.com.  Click here for an article on IRA Prohibited Transactions.

How to Use a Self-Directed IRA to Buy a Real Estate Investment

The process of buying a Real Estate asset in your Self-Directed IRA is quite simple. Since these accounts are Self-Directed, your first step is to locate an investment of your choosing. Once you have selected the property you would like to purchase within your IRA and you have completed the due diligence on your investment, you can complete your investment documents and work with your custodian to get your deal funded. 

Unlike when you make a Real Estate purchase from your personal funds, with a Self-Directed IRA, you MUST draw up the offer/contract in the name of the IRA. For example, if the buyer is a Quest client, the buyer’s name on the offer/contract reads: Quest Trust Company FBO [CLIENT’S FULL NAME] [IRA/HSA/ESA] # [ACCOUNT NUMBER]. It is important to make sure the vesting is correct to show that the purchaser is the IRA and to protect your investment. When listing the buyer’s address, it works the same way. Since the IRA is held by the custodian, you would use the custodian’s address. 

Oftentimes, custodians will have internal forms that will need to be completed at the time of investment. These forms will require the client to sign, giving their approval on the funding. Once all the proper documents are signed, the custodian will work with the 3rd party closing agent to close your Real Estate purchase. Since the custodian is the legal entity in administration of your IRA, the client will not have to attend any closings. Click here for steps on purchasing Real Estate in your Quest Trust IRA.

Maintaining Real Estate in an IRA

Real Estate investments usually come with ongoing responsibilities, such as property taxes or maintenance, and you will want to know what to do when those situations arise. First, it is important to understand that your IRA owns the investment, and it will need to be the IRA that pays for any expenses that are incurred. You cannot pay for any expenses out of your own pocket, as this would be a prohibited transaction. When an expense needs to be paid, you can contact your IRA custodian and follow the steps that they provide to have the IRA pay that expense. 

This may seem like an extra step, but it’s extremely important to maintaining your investment security. Paying any expense out of pocket for your IRA’s Real Estate asset is a prohibited transaction. You never want to jeopardize your growth potential by engaging in a prohibited transaction, so following all of the IRS’s rules and guidelines is imperative. If there is ever a situation that you have questions about, call your custodian and they will be happy to provide you with the education to help you make the best decision for your account.

When deciding to do a Real Estate investment in your Self-Directed IRA, be sure to choose a custodian that is familiar with the investments you plan to do. Time is a crucial factor in investing, especially in Real Estate, so finding a company that works fast and has ample knowledge on your types of investments will save you from missing out on a great deal. 

If you ever have a question about purchasing Real Estate in your IRA, call a Quest Trust IRA Specialist at 855.386.4727 and we can answer any questions you may have! To learn more about how to get started investing with a self-directed IRA, schedule a 1-on-1 consultation with an IRA Specialist by clicking HERE.

How Real Estate Syndication Works

Estimated reading time: 2 minutes

Real estate syndication is a strategy that investors can use to pool their resources and invest in large real estate projects. 

If you’re looking to invest in large real estate projects but don’t have the funds to get a project started on your own, syndication is a great strategy that you can use to get your foot in the door. 

Here’s what you need to know about real estate syndication:

What is real estate syndication?

Syndication is the process of pooling resources with other investors to invest in a large property or real estate project, such as an apartment complex or a commercial retail development. 

Syndication is not only the process of pooling financial resources, but also intellectual resources in order to make smart decisions about the properties you invest in. In a syndicated relationship, one party invests the money, while another party invests time and labor to find the property and run the day to day operations. 

The party investing the labor in the property is called the sponsor. Sponsors still invest some money, but the amount is much lower than what the investors put in. However, they still get a fair share of the profit. Syndicated partnerships are usually structured as an LLC.

Why get involved in real estate syndication?

Syndication has become much easier in recent years, as investors and sponsors can easily connect online. Crowdfunding has made real estate syndication much more accessible for the average person, because you can contribute relatively small amounts of money to a real estate project that is interesting to you, and reap the benefits accordingly. 

If you have a property that you are interested in, syndication is one of the best ways to get the project off the ground quickly. 

Real estate is a great investment, as it can serve as an excellent source of passive income for a very long time, and doesn’t fluctuate financially the same way that many other types of investments do.

Interested in real estate investing? Talk to the expert team at Quest Trust Company. Quest offers flexible investment account options designed to meet the needs of modern investors.

Mistakes Real Estate IRA Investors Make

Estimated reading time: 3 minutesFor investors who have the means, the time, and a custodian willing to handle one, real estate investments can be a great way to secure and grow funds for retirement. Most IRA accounts allow investors to choose from a variety of investments for where to place their retirement funds. Most choose to spread their wealth over a few options. Some are riskier with potential for a big pay-off, while others are safer with small growth potential. Real estate investments need a lot of time and attention afforded to them, so usually experienced investors who have extensive knowledge surrounding rental, flip, and/or new-build properties are the best candidates for investing in real estate.

Since real estate investments require more paperwork and detailed management than a typical investment, many investment groups don’t offer this option, or charge higher fees for their administration. Besides forgetting about additional fees that come with real estate investments, here are a few more mistakes real estate investors make:

  1. Renting to disqualified people. Many investors wonder if they can purchase a property with their IRA and use it for personal use or rent it to family. The answer is no on both accounts. Strict IRA Real Estate rules prohibit you or immediate family benefitting from or using the property in any way. This includes space to run a business, primary residence, or having connections to the rental company who operates on the property (such as an apartment complex).
  1. Putting personal equity into the property. Again, you must not benefit from the property in any way, other than at retirement. If you use personal funds for maintenance costs, the value will increase, and your investment will increase without any deductions. The same goes for “sweat equity”, or time you devote to repairing projects yourself. All maintenance costs, bills, taxes, and other fees must be paid for with your IRA money.
  1. Personally benefitting from profits. Just like you can’t put personal equity into the property, you can’t directly profit from the property either. For instance, you can’t take personal checks for rent payable to you. All generated income must be paid to the IRA itself. All profits and gains from the property are assessed when you take a deduction on your IRA or when you decide to transfer funds into another investment.
  1. Improperly filling out paperwork. Like other investments, real estate investments are made in the name of your IRA, not you. When filling out paperwork involving the property, transferring money, and accepting profits, you must always list actions as performed by your IRA.

Liquidating upon retirement. You won’t be required to sell any of your IRA investments upon retirement. Even traditional IRAs, which require minimum distributions once you reach 72, don’t force you to sell all of your investments in fulfilling this obligation. If the real estate market is in a down swing, you may want to wait until the value increases again before using the profits for your retirement. Remember to discuss all transactions with your financial planner before taking action.

Selecting Your First Real Estate Investment For Your Self-Directed IRA

Estimated reading time: 3 minutesLet’s say that like many individuals who are setting up their first self-directed IRA, perhaps drawn to the offerings of custodians such as Quest Trust Company because of the investment flexibility that such an account gives, you’re interested in using your new account to invest in real estate.

What are the next steps? How do you go about choosing your first real estate investment for your self-directed IRA?
What’s Your Prior Experience? When it comes to any new investment, there’s always some degree of learning as you go. But if you have very little or no experience with owning or managing real estate, then you may want to consider a more straightforward property for your first self-directed IRA investment.

What’s Your Investment Budget? Another key consideration is going to be the size of the investment budget for your first property. The more money you have available, the more options you’ll have.

As you formulate your budget, be sure to take into account the fact that any expenses for maintaining the property you buy must also come from within your self-directed IRA. This might be new contributions you are able to make each tax year, but these are subject to the annual contribution limits. Plan to either have your real estate generate enough income to pay for these expenses, or to incorporate other assets into your account in order to cover the real estate carrying costs.

What’s Your Current Portfolio Composition? Regardless of your preferred investment type, you always need to take care to avoid having too much of your portfolio committed to a single asset class. If you already have exposure to real estate in your portfolio (perhaps through banking stocks or REITs), then you want to factor that into your new investment considerations.

What’s the Purpose of the Real Estate Investment? Are you considering this real estate investment solely for potential gains, or do you have other goals in mind? For example, some people use their self-directed IRAs to purchase vacation or other properties that they intend to use themselves once they reach retirement age.

As you consider these types of investments, remember that the IRS regulations prohibiting self-dealing, meaning that you cannot use (nor can anyone in your family use) the property you buy until you take a distribution of it from your account during retirement (or face significant penalties if you take that distribution prior to retirement).

Start Small. Many first-time investors find that the best way to become more familiar with investing in real estate is to start small. This might be a single-family home, or even a condominium. Having a small investment in real estate can give you the opportunity to learn more first-hand, without over-committing your retirement portfolio to this type of asset.

Even though real estate is a fairly unique investment asset, it’s still subject to traditional financial analysis. Make sure you familiarize yourself with the local and broader real estate environment before making your first investment with your self-directed IRA.

Wealth Building Options for Your IRA

Estimated reading time: 8 minutesIn my last article on Option Strategies for Your IRA, I discussed option basics. In this article I will expand on the uses of options and how these strategies might be used to turn small amounts of cash into tremendous wealth in your IRA.

 
Simple Options. The most basic type of option is simply to have an option to purchase a piece of property for a specified price within a certain period of time. This is much better than a loan because it is similar to zero percent interest financing. For example, if a Health Savings Account (HSA) has a five year option to buy a piece of property for $50,000.00, then the HSA does not owe any more for the property at the end of the five years than it did at the beginning, yet the HSA effectively controls the property. This amounts to a five year, zero percent interest loan, but with no unrelated business income tax (UBIT)! You could even structure the option to have monthly or yearly renewal fees, so that it feels similar to a regular seller-financed loan for the property owner. With options all the burdens of owning the property, such as property taxes, insurance, and maintenance, continue to be on the property owner, thereby reducing your IRA’s risk!

 
Fix Up and Sell Options. Many investors are familiar with the typical buy, rehab and resell strategy for real estate. Suppose you created a deal in your Roth IRA where the repairs to be done are the consideration for the option? You and the property owner would agree on a specific list of repairs to be done, and the money for the repairs would come from your IRA. The option price would be based on the value of the property in its current condition. When the repairs are done the value of the property will have substantially increased, but your IRA has an option to purchase the property at the lower price. The value of your Roth IRA’s option is equal to the difference between the current, after repair fair market value and the original option price. As discussed in the prior article, your Roth IRA may, among other choices, 1) exercise its option and purchase the property, 2) assign the option for a fee to a retail buyer and let him purchase the property directly from the property owner, or 3) allow the property owner to sell directly to a retail buyer at a higher price while paying your Roth IRA a substantial fee to cancel the option!

 
Options on Ugly Property. What do you do if you locate a property that you think could probably be sold for a profit, but it is such a trashy piece of property or has so little equity that you are nervous about your IRA taking title to it? The solution is simple: have your IRA purchase an option from the property owner, stick a sign on the property, and try to find a buyer for the property which will give your IRA a profit. Options under these circumstances can often be purchased with very little money from your IRA. Even if your IRA ends up not exercising its option sometimes, overall this can be an incredibly powerful wealth building strategy.

 

 
Options on Partial Interests. What if there were several heirs owning a property you wanted your IRA to buy, but the heirs did not get along or did not agree to a certain price? Rather than giving up, have your IRA buy an option to purchase each heir’s interest separately.

The price would not have to be equal to each heir. Once you have negotiated options with all the heirs, you could add up the price and see if your IRA could market the property for a profit.

 
Low Ball Offers and the Right to Cancel. Suppose you want to make a low ball offer on a piece of property. The seller wants too much for the property, and you think he won’t get his price. On the other hand, he has to sell by a certain date for whatever reason (foreclosure, closing on a new house, moving out of town, etc.). Tell the seller this: “If you sell my daughter’s Coverdell Education Savings Account (ESA) an option to purchase the property for my price, I will give you the right to cancel the option within the next 30 days if you return the option fee plus $2,500.00. That way, if you find someone to pay you more than you would get from me who can close quickly enough you can sell the property to them and cancel the option, but you know you have a guaranteed sale if you can’t sell it to someone else on time.” How’s that for overcoming objections to a low ball offer? Your daughter’s ESA either gets the property at a bargain price or the seller pays her ESA not to buy!

 
Long Term Options. Long term options can be particularly powerful within an IRA, especially if your retirement is not imminent. Although many options used by IRAs are for shorter time periods, a long term option can turn out to be a fantastic investment. For example, in Houston, Texas there is an area called the Heights. This is close to downtown and many urban professionals are purchasing property in the area to avoid the horrible commute. Old properties are being purchased by individuals and developers who knock the houses down and build new homes on the lots. It is an area in transition. Prices have skyrocketed. Wouldn’t it be great if your IRA had 5 or 10 year options on several pieces of property in a redeveloping area such as the Heights or in the growth path of a city? Even if the option was to purchase the property for full fair market value or higher in today’s market, the longer term of the option may allow for a natural increase in the fair market value of the property

 
Rights of First Refusal. Another technique that can be used either alone or in conjunction with an option is a right of first refusal. A right of first refusal by itself is not an option to buy. It only means that the seller agrees not to sell the property to anyone else before first offering it to the holder of the right of first refusal. This is commonly used in business transactions, and can be used in real estate as well. Sales price and other terms are not typically negotiated in a pure right of first refusal, since it is only the right to buy the property at whatever price and on whatever terms the owner wants to sell.
When combined with a long term option, this strategy can pay off even if the option price is as high or higher than the current fair market value. For example, what if your IRA has an option to purchase a property in a growth path area for $100,000.00, and the option has a right of first refusal clause in it. In other words, any time the property owner wants to sell the property to a third party he would have to offer it to your IRA under the same terms. If the property owner wants to sell the property to a third party for $80,000.00, your IRA will also have the option to purchase it for that price because your IRA’s option has a right of first refusal clause. But suppose $80,000 is at or near the current fair market price and so exercising the option is not a good deal for your IRA. Assuming your option agreement is structured in a way that the option does not expire merely because of a transfer of ownership, the new owner of the property will have to take the property subject to that option. This of course limits his ability to sell the property in the future for more than your option price. Also, if a notice of option is filed in the real property records the buyer’s lender may require that the option be released. What is the value of your option under these circumstances, even though it is at a higher price than the current fair market value? The answer is however much the owner and buyer are willing to pay your IRA to cancel the option if that’s what you want!

 
Options and Shared Appreciation Mortgages. Has your IRA ever made a hard money loan and you thought, “I’d sure like my IRA to have a piece of that property! What a great deal!” Here is an interesting concept: loan the money to the investor at a low interest rate in exchange for an option to purchase a certain percentage of the property at the initial purchase price. One investor I know was able to use this method to purchase a property at a discount with a tenant in the property. Because the tenant was already in the property with a long term lease, he could not make the deal work using regular hard money rates. His solution was to borrow the money for the purchase and rehab from a friend’s IRA. The IRA received 6% interest plus an option to purchase a 50% interest in the property at one-half original purchase price. The investor walked away from closing with $3,000 in his pocket, a rental property with cash flow, and 50% of the future appreciation! Another possible structure is a loan with an option to convert from debt to equity.

 
Options on Personal Property. Options are most commonly discussed in terms of real estate. However, there is nothing which says you cannot purchase an option on personal property. For example, in many states the beneficial interest in a land trust is considered to be personal property. You may want to have your IRA purchase an option on a discounted note to see if it can be sold for a profit. I have even heard of people having an option in their IRA on automobiles being purchased by an investor at car auctions.

 
Options can be purchased in all types of Quest self-directed accounts, including Roth, traditional, SEP and SIMPLE IRAs, Individual 401(k)s, Coverdell Education Savings Accounts (ESAs), and even Health Savings Accounts (HSAs). Options are so incredibly powerful and flexible that I cannot discuss all the opportunities in one short article. I hope this article has opened your mind to new possibilities for your IRA. As I always say in the context of self-directed IRAs, “I don’t think outside the box, the box is just bigger than you think!”

Frequently Asked Questions About Buying Debt Financed Real Estate in an IRA

Estimated reading time: 6 minutesGood news!  You can buy real estate in your traditional, Roth, SEP, or SIMPLE IRA, your 401(k), your Coverdell Education Savings Account for the kids, and even in your Health Savings Account.  Even better, your IRA can borrow the money for the purchase or even take over a property subject to existing financing.  What could be better than building your retirement wealth using OPM (Other People’s Money)?  However, there are some restrictions which you must be aware of when using your IRA to purchase debt financed real estate.  Below I answer a series of frequently asked questions regarding the purchase of debt financed real estate in an IRA.
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Q.        Is it really legal to buy real estate in an IRA?

A.        Yes.  Even the IRS agrees that real estate is a permitted investment.  In its answer to the question “Are there any restrictions on the things I can invest my IRA in?” the Internal Revenue Service states “IRA law does not prohibit investing in real estate but trustees are not required to offer real estate as an option.”

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Q.        Can my IRA buy real estate with a loan or take over a property subject to an existing loan?

A.        Yes.  An IRA may borrow money to acquire real estate or take over a property subject to an existing loan, provided that the loan is non-recourse to the IRA and to any “disqualified person.”  This means that typically the lender may only foreclose on the property in the event of a default.  Even if there is a deficiency, the lender cannot come after the rest of the IRA’s assets, nor can the lender come after the IRA owner or any other disqualified person.  Neither the IRA holder nor any other disqualified person is permitted to sign a personal guarantee of the debt.

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Q.        Where can I get a non-recourse loan for my IRA?

A.        There are at least four sources for financing which do not violate the non-recourse requirements for IRA’s.  First, there is seller financing.  Most sellers understand that if the loan goes into default they get the property back anyway, so asking for the loan to be non-recourse should not be too difficult to negotiate.  Second, there is private financing from financial friends.  If you cultivate a reputation as a professional real estate investor, there should be no reason that your financial friends would not loan your IRA money on a non-recourse basis, either from their own funds or from their own IRA’s.  I have seen

IRA’s borrow the money for both the purchase and the rehab on a non-recourse loan!  Third, there are banks and hard money lenders.  Non-recourse loans are not the norm, so many banks will turn you down.  However, there is at least one bank that lends in all 50 states, and in Houston I have had at least 3 local banks and 2 hard money lenders make non-recourse loans to IRA’s.  Finally, as mentioned above, you could take over a property subject to an existing loan, provided the originator of the loan is not you or another disqualified person.

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Q.        Is there any tax effect of having an IRA own debt financed real estate?

A.        Yes.  Income and gains from investments in an IRA, including real estate, are normally not taxed until the income is distributed (unless the distribution is a qualifying distribution from a Roth IRA, a Coverdell Education Savings Account, or a Health Savings Account, in which case the distribution is tax free).  However, if the IRA owns property subject to debt, either directly or indirectly through an LLC or a partnership, it may owe tax on the net income from the property or partnership.

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Q.        If the profits from an investment are taxable to an IRA, does that mean it is prohibited?

A.        Absolutely not!  There is nothing prohibited at all about making investments in your IRA which will cause the IRA to owe taxes.

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Q.        But if an investment is taxable, why do it in the IRA?

A.        That is a good question.  To figure out if this makes sense, ask yourself the following key questions.  First, what would you pay in taxes if you made the same investment outside of the IRA?  The “penalty” for making the investment inside your IRA, if any, is only the amount of tax your IRA would pay which exceeds what you would pay personally outside of your IRA.  Unlike personal investments, the IRA owes tax only on the portion of the net income related to the debt, so depending on how heavily leveraged the property is the IRA may actually owe less tax than you would personally on the same investment.  Second, does the return you expect from this investment even after paying the tax exceed the return you could achieve in other non-taxable investments within the IRA?  For example, one client was able to grow her Roth IRA from $3,000 to over $33,000 using debt financed real estate in under 4 months even after the IRA paid taxes on the gain!  Third, do you have plans for re-investing the profits from the investment?  If you re-invest your profits from an investment made outside of your IRA you pay taxes again on the profits from the next investment, and the one after that, etc.  At least within the IRA you have the choice of making future investments which will be tax free or tax deferred, depending on the type of account you have.

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Q.        If the IRA pays a tax, and then it is distributed to me and taxed again, isn’t that double taxation?

A.        Yes, unless it is a qualified tax free distribution from a Roth IRA, a Health Savings Account (HSA) or a Coverdell Education Savings Account (ESA).  The fact is that you still want your IRA to grow, and sometimes the best way to accomplish that goal is to make investments which will cause the IRA to pay taxes.  Keep in mind that companies which are publicly traded already have paid taxes before dividends are distributed, and the value of the stock takes into consideration the profits after the payment of income taxes.  In that sense, even stock and mutual funds are subject to “double taxation.”

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Q.        If the IRA makes an investment subject to tax, who pays the tax?

A.        The IRA must pay the tax.

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Q.        What form does the IRA file if it owes taxes?

A.        IRS Form 990-T, Exempt Organization Business Income Tax Return.

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Q.        What is the tax rate that IRA’s must pay?

A.        The IRA is taxed at the rate for trusts.  Refer to the instructions for IRS Form 990-T for current rates.

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Q.        Is there any way to get around paying this tax?

A.        Yes.  In some ways it may be considered a “voluntary” tax, since investments can often be structured in such a way as to avoid taxation.  Some ways to structure your IRA investment to avoid taxation include loaning money instead of acquiring the real estate directly or purchasing an option on the real estate, then assigning or canceling the option for a fee.  These techniques have a disadvantage in that they may not result in as much profit to the IRA, but will generally be free of tax.  There is also an exemption from this tax for 401(k)’s and other qualified plans in certain circumstances.

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Q.        Where can I find out more information?

A.        Visit our website at www.QuestIRA.com for more information.  Also, Unrelated Business Taxable Income and Unrelated Debt Financed Income are covered inIRS

Publication 598, which is freely available on the IRSwebsite at www.irs.gov.  The actual statutes may be found in Internal Revenue Code §511-514.

There is one general truth that applies both inside and outside of an IRA – you can do more with debt than you can without it.  Despite the increased risk from debt and the taxes due on income from debt financed property, a careful analysis may lead to the conclusion that having your IRA pay taxes now may be the way to financial freedom in your retirement.  Be sure to have your IRA pay the tax if it owes it, though.  As I always say, “Don’t mess with the IRS, because they have what it takes to take what you have!”

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Option Strategies for Your IRA

Estimated reading time: 13 minutesMany people would like to buy real estate in their IRAs but have a mistaken belief that they do not have enough money to do so.  Nothing could be further from the truth!  You may invest in real estate with your IRA without a lot of money in several ways, including partnering with other IRAs or non-IRA money, buying property with debt, or by using one of the most powerful and under utilized tools in real estate investing today – the option.

First, what is an option?  Once consideration for the option is paid, it is the owner’s irrevocable offer to sell the property to a buyer under the terms of the option for a certain period of time.  The buyer has the right but not the obligation to buy.

You might wonder why an owner would agree to tie up his property with an option.  Advantages to a property owner include:  1) the owner may be able to time his income for tax purposes, since option fees are generally taxable when the option is either exercised or expires (always check with your tax advisor); 2) if the owner needs money, an option may be a way to get money that he doesn’t have to repay, unlike a loan; 3) options are very flexible, and the owner may be able to negotiate an option which allows him to keep the property until a more opportune time – this is especially true of an owner in a pre-foreclosure situation.

Do the paperwork right!  Options are extremely powerful and very easy to mess up.  Be very specific, clear and complete about all the details.  Remember, with options, you have to negotiate for both the option and for the purchase of the property.  With a well written option, the following must be, as my old law professor was fond of saying, “patently obvious to the most casual observer”:

a)         Who is granting the option?  Does it include heirs, successors and assigns?

b)         Who is receiving the option?  Does it include assignees of the buyer, or is it an exclusive option to purchase by the buyer only?

c)         What property is being optioned?  Property can be anything, including real estate, a beneficial interest in a land trust, a real estate note or nearly anything else.

d)         What is the consideration for the option?  Remember, there must be some consideration for the option in the form of money, services or other obligations.

e)         How is the option exercised by the buyer?  This is one of the easiest things to mess up in an option.  If the procedure is not clear for exercising the option, it is an invitation to litigation!

f)         What will be the purchase price of the property if the option is exercised?

g)         How will the purchase price be paid when the option is exercised?  Will it be for cash?  Seller financing?  Subject to the owner’s existing mortgage?

h)         Will the option consideration be credited to the option price or not?

i)          When can the option be exercised?  For example, does the option holder have the right to exercise the option at any time during the option period, or can the option only be exercised after a specified amount of time?

j)          When will the option expire, and under what circumstances?  The option should have a definite termination date, but might also include other circumstances under which the option terminates, such as a default under a lease.

k)         When it comes time to close, what are each party’s obligations?  For example, who pays for title insurance, closing costs, etc?  Are taxes prorated?

So what forms do you use?  The answer is my favorite as a lawyer – it depends!  There is not and cannot be a “standard” option for all purposes.  They are simply too flexible.  You must decide on a specific use for the option and then, as Shakespeare said, “Get thee to a lawyer!” (Okay, it was “Get thee to a nunnery” but I like it better as revised!).

When you have negotiated an option agreement for your IRA, you have several choices.  First, you can let the option expire on its own terms.  Sometimes this is the best course of action if the deal is not what you expected, especially if you only paid a small amount for the option.

Another choice is that your IRA could exercise the option and buy the property.  Since there are ways to finance property being purchased by your IRA, including seller financing, bank financing, private party financing or even taking over property subject to a loan, this may be a good strategy for your IRA, even if the IRA does not have the cash to complete the purchase.  Be aware that if your IRA owns debt financed property, either directly or indirectly through an LLC or partnership, its profits from that investment will be subject to Unrelated Business Income Tax (UBIT).  This is not necessarily a bad way to build your retirement wealth, but it does require some understanding of the tax implications.

A third choice which is often employed in the context of self directed retirement accounts is to assign your option to a third party for a fee.  Your option agreement should specifically allow for an assignment to make sure that there are no problems with the property owner.  This is a great technique for building a small IRA into a large IRA quickly.  I had one client who put a contract on a burned house for $100 earnest money in his daughter’s Coverdell Education Savings Account, then sold his contract to a third party who specialized in repairing burned houses for $8,500.  In under 1 month the account made a profit of 8,400%, and all parties were happy with the deal!  The account holder then immediately took a TAX FREE distribution to pay for his daughter’s private school tuition.

A fourth choice that sometimes is overlooked is the ability to release the option back to the property owner for a cancellation fee.  In other words, this is a way for your IRA to get paid not to buy!  Let me give you an example of how this might work.  Suppose you want to offer the seller what he would consider to be a ridiculously low offer.  When the seller balks, you say “I’ll tell you what.  You sign this option agreement for my IRA to purchase this property at my price, and we’ll put in the option agreement that I cannot exercise my option for 30 days.  If you find a buyer willing to offer you more money within that 30 day period, just reimburse my IRA the option fee plus a cancellation fee of $2,500.”  Either way, your IRA wins!

There are various ways in which an option might be used to turn small amounts of cash into tremendous wealth in your IRA.  Some examples of the uses of options include the following:

Simple Options.  The most basic type of option is simply to have an option to purchase a piece of property for a specified price within a certain period of time.  This is much better than a loan because it is similar to zero percent interest financing.  For example, if a Health Savings Account (HSA) has a five year option to buy a piece of property for $50,000.00, then the HSA does not owe any more for the property at the end of the five years than it did at the beginning, yet the HSA effectively controls the property.  This amounts to a five year, zero percent interest loan, but with no unrelated business income tax (UBIT)!  You could even structure the option to have monthly or yearly renewal fees, so that it feels similar to a regular seller-financed loan for the property owner.  With options all the burdens of owning the property, such as property taxes, insurance, and maintenance, continue to be on the property owner, thereby reducing your IRA’s risk!

Fix Up and Sell Options.  Many investors are familiar with the typical buy, rehab and resell strategy for real estate.  Suppose you created a deal in your Roth IRA where the repairs to be done are the consideration for the option?  You and the property owner would agree on a specific list of repairs to be done, and the money for the repairs would come from your IRA.  The option price would be based on the value of the property in its current condition.  When the repairs are done the value of the property will have substantially increased, but your IRA has an option to purchase the property at the lower price.  The value of your Roth IRA’s option is equal to the difference between the current, after repair fair market value and the original option price. As discussed in the prior article, your Roth IRA may, among other choices, 1) exercise its option and purchase the property, 2) assign the option for a fee to a retail buyer and let him purchase the property directly from the property owner, or 3) allow the property owner to sell directly to a retail buyer at a higher price while paying your Roth IRA a substantial fee to cancel the option!

Options on Ugly Property.  What do you do if you locate a property that you think could probably be sold for a profit, but it is such a trashy piece of property or has so little equity that you are nervous about your IRA taking title to it?  The solution is simple:  have your IRA purchase an option from the property owner, stick a sign on the property, and try to find a buyer for the property which will give your IRA a profit.  Options under these circumstances can often be purchased with very little money from your IRA.  Even if your IRA ends up not exercising its option sometimes, overall this can be an incredibly powerful wealth building strategy.

Options on Partial Interests.  What if there were several heirs owning a property you wanted your IRA to buy, but the heirs did not get along or did not agree to a certain price?  Rather than giving up, have your IRA buy an option to purchase each heir’s interest separately.  The price would not have to be equal to each heir.  Once you have negotiated options with all the heirs, you could add up the price and see if your IRA could market the property for a profit.

Low Ball Offers and the Right to Cancel.  Suppose you want to make a low ball offer on a piece of property.  The seller wants too much for the property, and you think he won’t get his price.  On the other hand, he has to sell by a certain date for whatever reason (foreclosure, closing on a new house, moving out of town, etc.).  Tell the seller this: “If you sell my daughter’s Coverdell Education Savings Account (ESA) an option to purchase the property for my price, I will give you the right to cancel the option within the next 30 days if you return the option fee plus $2,500.00.  That way, if you find someone to pay you more than you would get from me who can close quickly enough you can sell the property to them and cancel the option, but you know you have a guaranteed sale if you can’t sell it to someone else on time.”  How’s that for overcoming objections to a low ball offer?  Your daughter’s ESA either gets the property at a bargain price or the seller pays her ESA not to buy!

Long Term Options.  Long term options can be particularly powerful within an IRA, especially if your retirement is not imminent.  Although many options used by IRAs are for shorter time periods, a long term option can turn out to be a fantastic investment.  For example, inHouston,Texas there is an area called the Heights.  This is close to downtown and many urban professionals are purchasing property in the area to avoid the horrible commute.  Old properties are being purchased by individuals and developers who knock the houses down and build new homes on the lots.  It is an area in transition.  Prices have skyrocketed.  Wouldn’t it be great if your IRA had 5 or 10 year options on several pieces of property in a redeveloping area such as the Heights or in the growth path of a city?  Even if the option was to purchase the property for full fair market value or higher in today’s market, the longer term of the option may allow for a natural increase in the fair market value of the property

Rights of First Refusal.  Another technique that can be used either alone or in conjunction with an option is a right of first refusal.  A right of first refusal by itself is not an option to buy.  It only means that the seller agrees not to sell the property to anyone else before first offering it to the holder of the right of first refusal.  This is commonly used in business transactions, and can be used in real estate as well.  Sales price and other terms are not typically negotiated in a pure right of first refusal, since it is only the right to buy the property at whatever price and on whatever terms the owner wants to sell.

When combined with a long term option, this strategy can pay off even if the option price is as high or higher than the current fair market value.  For example, what if your IRA has an option to purchase a property in a growth path area for $100,000.00, and the option has a right of first refusal clause in it.  In other words, any time the property owner wants to sell the property to a third party he would have to offer it to your IRA under the same terms.  If the property owner wants to sell the property to a third party for $80,000.00, your IRA will also have the option to purchase it for that price because your IRA’s option has a right of first refusal clause.  But suppose $80,000 is at or near the current fair market price and so exercising the option is not a good deal for your IRA.  Assuming your option agreement is structured in a way that the option does not expire merely because of a transfer of ownership, the new owner of the property will have to take the property subject to that option.  This of course limits his ability to sell the property in the future for more than your option price.  Also, if a notice of option is filed in the real property records the buyer’s lender may require that the option be released.  What is the value of your option under these circumstances, even though it is at a higher price than the current fair market value?  The answer is however much the owner and buyer are willing to pay your IRA  to cancel the option if that’s what you want!

Options and Shared Appreciation Mortgages.  Has your IRA ever made a hard money loan and you thought, “I’d sure like my IRA to have a piece of that property!  What a great deal!”  Here is an interesting concept:  loan the money to the investor at a low interest rate in exchange for an option to purchase a certain percentage of the property at the initial purchase price.  One investor I know was able to use this method to purchase a property at a discount with a tenant in the property.  Because the tenant was already in the property with a long term lease, he could not make the deal work using regular hard money rates.  His solution was to borrow the money for the purchase and rehab from a friend’s IRA.  The IRA received 6% interest plus an option to purchase a 50% interest in the property at one-half original purchase price.  The investor walked away from closing with $3,000 in his pocket, a rental property with cash flow, and 50% of the future appreciation!  Another possible structure is a loan with an option to convert from debt to equity.

Options on Personal Property.  Options are most commonly discussed in terms of real estate.  However, there is nothing which says you cannot purchase an option on personal property.  For example, in many states the beneficial interest in a land trust is considered to be personal property.  You may want to have your IRA purchase an option on a discounted note to see if it can be sold for a profit.  I have even heard of people having an option in their IRA on automobiles being purchased by an investor at car auctions.

Options can be purchased in all types of Quest self-directed accounts, including Roth, traditional, SEP and SIMPLE IRAs, Individual 401(k)s, Coverdell Education Savings Accounts (ESAs), and even Health Savings Accounts (HSAs).  Options are so incredibly powerful and flexible that I cannot discuss all the opportunities in one short article.  I hope this article has opened your mind to new possibilities for your IRA.  As I always say in the context of self-directed IRAs, “I don’t think outside the box, the box is just bigger than you think!”