Copyright (c) 2014 Joseph M. Maas
This article is a continuation from Part 1 in which we discussed how to use IRAs to purchase property investments.
In many cases, the IRA holder will have sufficient funds to cover the real estate purchase, but what if a great investment property for your IRA is discovered, and your retirement account simply doesn't have adequate funds? Fortunately, there are several ways you can make the purchase and still keep the transaction legal and profitable.
2. Tenancy-in-Common (TIC)
3. Limited Liability Companies (LLC)
Loans: Debt financing to purchase real estate in a self-directed IRA is permitted when you use the IRA-purchased property, not the IRA itself, as security for the loan. This type of permitted borrowing is called non-recourse lending. A non-recourse loan is not like the loan on your personal residence. If the loan isn't paid back as promised, the lender may take the IRA-owned property used to secure the debt. Because of its unique nature, not many banks or lending institutions offer these types of loans, but they do exist. Your self-directed IRA custodian may be able to direct you toward a lender.
Like other loans, non-recourse loans have a monthly payment and some type of amortization schedule, which will need to be followed. Therefore, your IRA property will need to make the loan payments from its cash flow, its annual IRA contributions, or some combination of the two. Simply put, you need to have more money coming into your IRA than going out. This also means you need to have sufficient liquidity in your IRA for other real estate related expenses such as property taxes, insurance, and repairs and maintenance. Remember, the IRA itself must pay all expenses.
In addition to annual operating expenses, in accordance with Section 511 of the Internal Revenue Code, if your IRA property has debt, or if a mortgage was incurred with its acquisition, you must pay annual taxes on any income produced. This special tax is called Unrelated Business Taxable Income (UBTI). Please note that this tax does not apply to every property purchased with an IRA, but only those that have related debt.
Tenancy-in-Common (TIC): Tenancy-in-common is a form of concurrent ownership in which two or more persons each have an undivided interest in the entire property, but no right of survivorship. Because each person's interest, or share, is undivided, each can sell his share at any time without the consent or agreement of the others. So, how does this help you? Here is an example:
You and two of your friends find a good property to invest in, and the purchase price is $100,000. With a tenancy-in-common arrangement, you can buy the property together, with each person putting in the amount of money he or she has available. Each will own a prorated percentage of the property, the income generated from its operation, and, eventually, a percentage of the profits when the property is sold.
Tenancy in Common Example
You, $60,000, 60%
Tom $20,000, 20%
Rob $20,000 20%
Total $100,000 100%
A tenancy-in-common arrangement also allows use of both IRA funds and non-IRA discretionary funds to buy a single investment. It is not a requirement that each of the owners use the same type of funds as the others.
Tenancy in Common Using IRA and Non-IRA Funds
You $60,000, 50% IRA/50% Cash
Tom $20,000, 100% IRA
Rob $20,000, 100% Cash
Total $100,000, 100%
Limited Liability Companies (LLC): The limited liability company is another flexible option. Using an LLC is similar to investing in a real estate investment trust (REIT) because your IRA may be invested in limited interests with other investors. The difference is that LLCs are private, and there are usually only a few investors involved in the purchase and ownership.
As with everything, once you begin to explore an idea, the complexity increases and new questions surface. When considering creative real estate investment tactics, always consult with a professional financial planner.
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Did you know you could use your IRA to purchase property investments? If you follow the relevant IRS regulations, it is possible. Learn more about this at Synergetic Finance or in author Joseph M. Maas' book "Exit Insight: Getting to Sold!" available at Merrell Publishing
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