by Daniel Cordoba, CEA
These days, with the lackluster performance and uncertainty of the stock market, it’s no secret that many investors would prefer to have more choice, and control over, where they invest their retirement accounts. With close ties to the housing market, realtors and other industry professionals are in a prime position to capitalize on a growing trend -investing in real estate with a self-directed IRA.
Though it is not an option offered by most conventional financial planners who operate on commissions from stocks and bonds, a growing number of real estate professionals are learning that they and their clients can invest in real estate and other non-traditional assets with their IRAs. For individuals that do not have cash on hand, or who simply want to diversify their retirement portfolios, this option offers the ability to invest in real estate - historically less risky than the stock market.
Doug Cady, a realtor in the Kissimee area of Florida, used his industry knowledge and experience to purchase two properties last year with his IRA. He made minor cosmetic renovations and put them back on the market for a total profit of $110,000. As a realtor, Cady’s past experience and familiarity with the local market helped him to know which properties would make the best investments for what he was trying to do.
“I looked for the cheaper houses in an area, the ones that didn’t have upgrades to begin with and maybe needed some cleaning up,” says Cady. “Those are the properties that don’t cost that much, and by making some minor cosmetic renovations and touch-ups, like paint, you get your return back.”
Cady also knew that the best deals were on houses that had been on the market for awhile. His returns on both properties totaled nearly 26% on a total investment of $429,000 in five months - money that had been sitting in mutual funds and hadn’t changed much in value over the last five years, he says.
Cady says he wanted to invest in real estate because it’s good money, especially for the short term, and being a realtor gives him knowledge that helps him to be in the “driver’s seat” when it comes to his own retirement. “There aren’t a lot of deals out there since homes are bringing top dollar, so you have to be a little creative and looking all the time. Being a realtor helps with that. I also knew that buying the houses that needed major renovations wasn’t the way to go,” he says.
The appreciation and cash flow that can result from purchasing investment real estate with an IRA provides industry professionals with a number of favorable tax benefits. Also, unlike with 1031 exchanges, there are no specific investment timelines or requirements to purchase “like kind” investments when buying real estate with an IRA. When the property is sold, the IRA prevents any capital gain exposure, since taxation of an IRA does not occur until distribution.
A Roth IRA provides even greater tax savings benefits, since it is tax-deferred while growing, and tax-free upon distribution (unlike with a traditional IRA, which is taxed at the time of distribution). In addition, a Roth IRA has no minimum distribution, so it is up to the investor, when (after 59½), and how much he or she takes as a distribution. The Roth IRA may also be passed on to heirs without taxation.
Realtors familiar with this self-directed IRA option can offer their knowledge as a value-add to clients and associates. Like Cady, Janice Campbell and her husband Sunny of Austin, Texas, are realtors who purchased a residential property using their IRA, renovated it and resold it for a $20,000 profit.
The Campbells say they are happy with the outcome and are always looking at different avenues for other real estate IRA investments. “When we first learned about this, no one else in our area had tried it. So when the investment opportunity came along, we decided to try it under the guidance of Asset Exchange Strategies,” says Janice, who used the self-directed IRA advisor to provide advice, set up the necessary entities and handle all the paperwork. “It ended up being simpler, faster and much more convenient to us than having to get a conventional mortgage.”
Now, Janice and Sunny regularly educate potential clients and prospects about using their IRAs to invest in real estate, because they see it as a win-win situation. “They can’t believe how simple it is,” she says. “And it’s a benefit to us because it allows us to build a niche in the market. By getting investors interested in this option, we can work with them to help them find the right properties to invest in and make a commission from those sales.”
Although it is an option quickly growing in popularity, investing in real estate with a Roth or other type of IRA is not something that investors - even those in the real estate industry - should undertake on their own, primarily because of the strict rules and transaction guidelines the IRS sets forth. Instead investors should enlist the help of a self-directed IRA advisor to guide them through the process. Unlike a traditional financial advisor, they will have an extensive understanding of the legal considerations involved in self-directed IRAs and a strong background to provide solid advice.
A self-directed IRA advisor should also possess the knowledge to leverage IRA LLCs, a specialized vehicle compliant with IRS regulations, offering substantial control and flexibility to the IRA holder. Kelly Troy, a real estate investment mentor found out during his investigation that the garden variety LLC operating agreement created by individuals without the expertise could actually cause your IRA to be disqualified. “Sometimes people try to do things themselves and the cost is many times more the cost of doing it right the first time.” says Troy who has also helped several of his students set up IRA LLCs.
Good investment opportunities often require the ability to act quickly and write checks for IRA funds, which can be accomplished through “checkbook control” offered by the IRA LLC. In addition to giving the investor more freedom in making transactions and enabling him/her to act quickly in a competitive real estate market, the IRA LLC also helps to protect the assets and retirement account.
Rick Prekup of Horseshoe Bay, Texas, is currently in the process of putting his IRA into an IRA LLC in order to have the ability to write checks for his self-directed IRA investments. As VP of sales and business development for a company that makes printed circuit boards, Prekup does not have the time to buy houses and fix them up, but is happy to fund the process. Most recently his investments involve lending money from his IRA to rehabbers at 14% interest, which he then rolls back into the IRA after it is paid back, typically in six to seven months.
When he does come across a good investment opportunity, “The IRA LLC gives me the ability, when I find a deal, to put 20% down by writing a check from my IRA,” he said.
Prekup had already bought and sold several properties over the years using traditional methods before he started investing in real estate with his IRA, but cites substantial tax benefits he receives from the latter, especially since he converted his self-directed IRA to a Roth IRA, which means the investments will be exempt from taxes on all future gains. But he agrees you must follow the rules and choose your team carefully. “I am the master of my destiny. I’ve always done well,” he says. “But you have got to do your homework. Trust no one and follow up on everything. I looked into Asset Exchange thoroughly before I decided to go with them and made sure everything checked out.”
With the many advantages that non-traditional IRA investments enable - including greater control over investment options, tax favorable income and perhaps most importantly, the potential to count on higher returns with less risk than with stocks and bonds - they can be a highly valuable vehicle for investors of all levels. Working with an advisor that can meet their needs, real estate professionals and others can put their expertise to work for them in intelligently looking to real estate as an alternative investment for retirement.
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