So what are the most important aspects you should know and understand so that when you find the perfect investment property you are ready to make the move on it without hesitation or missing the opportunity at hand!
Rules of the game!
First and foremost you need to understand that you are not really purchasing the investment property your IRA is making the purchase. You must first transition your IRA over to a Self Directed IRA. In order for your IRA to purchase investments you must go through an IRA Custodian.The custodian is the company that handles all of the transactions for your investments and specializes in the self direct IRA for investment real estate they in fact disburse all the funds for you and hold the title in your IRA’s name.
In order for the IRA to be treated as a retirement investment and be protected it has to have a custodian. Under the self Directed IRA you cannot even place $1.00 of your personal funds into the deal or you can cancel out the entire program.
Here are some of the most important mistakes people must avoid!
1. They inadvertently make personal guarantees.
You, as the individual holding the account are considered a “disqualified Person” and cannot provide a personal guarantee of IRA debt. In order to obtain checkbook control of retirement monies, you will have to invest your account into a newly formed LLC which is setup by the custodian. Let’s say you personally go to the bank and setup the account and the bank person ask if you would like a credit card also, you make application and the card it approved you have just made a personal guarantee for your IRA “Bad Move”! The mere execution of that personal guarantee constitutes an “extension of credit” and, hence, is an automatic prohibited transaction even if the guarantee is never exercised.
2. The IRA owner attempts to make a contribution to the IRA by depositing it directly into the IRA/LLC checking account instead of going through the IRA custodian. In essence, if you make an annual contribution directly rather than through the IRA custodian, you are personally interacting with your IRA/LLC. That is considered a prohibited transaction.
3. The IRA owner personally enters into a contract on real property they intend to purchase with their IRA funds. Many investors wait until they find a property in order to engage the services of an IRA custodian or facilitator. Unfortunately, in doing so, they often suffer from” opportunity loss”
A. a self-directed IRA typically takes 30 days to establish.
B. they are not allowed under the prohibited transactions code to use personal assets for the benefit of the IRA.
C. For example, let’s say you find a great piece of rental real estate you’d like to buy as an IRA investment. If you have not already established a self-directed IRA account, you may lose out on the deal because you don’t have immediate access to your IRA funds and you cannot personally deposit your own earnest money or enter into a purchase agreement. Remember, the IRA needs to buy the property, not you.
4. They assume no UBTI “Unrelated Business Taxable Income applies to passive investments into an operating business. If generated, the IRA has to pay Unrelated Business Income Tax, and all bills pertaining to the investment, you cannot use any person funds.
5. Self-directed IRA clients use personally-owned assets for the benefit of the IRA. For example, the use of a personally-owned bulldozer and construction equipment to develop IRA-owned property would constitute a prohibited transaction. There are multiple layers of problems with this scenario, because you are mingling business assets and you also cannot use sweat equity it will be counted as a contribution.
6. They believe that transactions with a non-disqualified party cannot be prohibited transactions. This is a common belief that simply is not true. You, as the IRA holder, have a fiduciary responsibility to do what is in the exclusive benefit of your IRA. For example, an IRA holder could purchase rental real estate and allow a brother and their family to occupy the property. That would not necessar¬ily be a prohibited transaction, but it does stage the potential to violate the exclusive benefit rule if the rent was not set at fair market value and the terms of the property agreement were not enforced. The problem here is as the landlord you have to evict tenants just like any other person and renting to a family member could constitute a conflict of interest.
7. The attempt by the self-directed IRA holder to take a real estate commission on property purchased/sold by the IRA. If the IRA owner is a real estate agent, they cannot receive a commission on the buying or selling of their IRA property. You cannot take personal compensation from any self-directed IRA investment.
8. The self-directed IRA enters into a de facto partnership in which it loans money to a developer, and instead of making a loan attached with interest and payments, it takes a share of the profits. Although this is allowed, it’s a de facto partnership that will generate Unrelated Business Taxable Income (UBTI). This wouldn’t be an issue if the IRA lent the money for an interest rate that the market bears with a monthly payment schedule established.
9. Two self-directed IRA holders engage in a quid pro quo partnership to utilize their own retirement funds. For example, say each person has $200,000 in a self-directed IRA. Each then makes a loan to the other for $200,000 to pursue personal investments. These loans are dependent on the other lending the money and could be viewed as using one’s own retirement funds for personal benefit.
10. Self-directed IRA holders attempt to “disguise” active investments that can generate UBTI. Some self-directed account holders will place an ad in the newspaper to supposedly show their intent to rent an IRA investment property, but they “conveniently” can’t find the right tenants, so they use this as an excuse to sell it. Even if it were true that the IRA holder originally intended to rent the property rather than turn around and sell it, the case law says that the most dominant factor is the purpose at the time of the sale, not at the time of the initial purchase. This type may make this transaction subject to UBTI.
The fact is a self directed IRA can be exciting, secure and profitable, there are so many allowable investment opportunities, but if you are thinking about how you could be doing this type of investing make sure you have the right people who make sure that you do not make mistakes that can be very costly in the end.
For more information about Real Estate IRA’S you will need to have a professional who understands that workings of the program before you even start looking at real estate.