Did you know you can use your IRA funds to purchase investments closer to home without the need to go through a broker or investment advisor? Most people don’t. Experienced in this area, we help clients facilitate these complex transactions, ensuring compliance with the various laws and regulations governing tax deferred retirement programs.
What is a Self-Directed IRA?
A self-directed IRA is not a unique type of IRA. The term self-directed simply refers to the way the account is administrated and the greater choice of investment options available to the account owner. Unlike more conventional retirement accounts, self-directed IRAs are controlled by the owners of those accounts, who have the freedom to choose from a large pool of alternative investments—like real estate, private lending opportunities, and much more—to build tax-free or tax-deferred wealth for retirement. The only assets you may not acquire in your IRA are life insurance policies and collectibles.
What Plans Can Be Used?
- Traditional IRA
- Roth IRA
- Simplified Employee Pension (SEP) IRA
- Savings Incentive Match Plan for Employees (SIMPLE) IRA
- Qualified Plan
- Education Savings Account
- Health Savings Account
How is the IRA Funded?
There are many ways real estate or other investments can be purchased in an IRA account. The most popular ways are the following four:
- Cash Purchase: If the IRA has enough funds for the entire purchase, it may purchase 100 percent of the asset.
- Partnering Funds: Your IRA can partner its funds with a friend, associate, family member or even with you personally. When partnering, any individual (or perhaps another IRA) can be a co-owner in the real estate asset (There are restrictions, to be discussed later)
- Borrowing Funds: An IRA can borrow money for investment purposes in the form of a non-recourse loan. When using a non-recourse loan, the IRA owner cannot personally guarantee the loan as IRS rules prohibit an individual from using their personal credit for the benefit of their IRA account. With a non-recourse loan, the property is used as collateral and the lender’s only recourse if there is a default is to simply foreclose on the property. Typically, these loans require a larger down payment and owner financing will qualify, so long as there is no personal guarantee from the IRA owner (When using financing with your IRA, the account may incur yearly unrelated business income tax).
- Seller Financing: An IRA can also borrow from the seller.
Using an IRA LLC to Invest
A new LLC can be set up naming the IRAs as members, allowing funds from the IRAs to be directed into the LLC. The manager of the LLC is in turn able to use the LLC funds to purchase investments, i.e. the real estate or other desired investment. This structure is typically used by individuals who are holding rental properties in the LLC or by multiple individuals who are purchasing larger assets. Such transactions require a great deal of accounting and the IRA owner is responsible for keeping complete and accurate records. Forming an LLC also creates additional costs and entails a supplementary set of rules that must be followed, but when done properly, it allows otherwise prohibited transactions and disqualified parties to be able to transact with one another. We recently represented a client that utilized this structure when several family members used their IRAs to purchase land via the creation of an LLC. The land is now being leased to a farmer, and the income generated is being paid to the IRA owned LLC.
Prohibited Transactions
A prohibited transaction is any improper use of an IRA account by the IRA owner, his or his beneficiary, or any disqualified person. In a self-directed IRA, there are a vast number of investment options. Account owners may not perform the following prohibited transactions:
- Sell, exchange or lease property to their IRA
- Vacation in or otherwise use property owned by their IRA
- Allow disqualified persons to vacation in or use property owned by their IRA
- Buy, sell or lease property from a disqualified person
- Receive compensation for managing property in their IRA
- Perform maintenance on the property held within their IRA
- Use their IRA property as security for a loan
- Personally borrow money from their IRA
- Transfer plan income or assets to disqualified person
- Lend money to disqualified person
- Furnish goods, services or facilities to disqualified person
- Allow fiduciaries to obtain or use the plan’s income or assets for their own interest
Disqualified Persons
There are certain individuals that your IRA cannot transact with, including:
- The IRA holder and his or her spouse
- The IRA holder’s lineal descendants/ascendants, and spouses of lineal descendants
- Investment advisors and managers
- Any corporation, partnership, trust or estate in which the disqualified person maintains
- control as a president, manager, etc.
- Anyone providing services to the IRA, such as the trustee or custodian
If handled and structured correctly, pooling funds with a disqualified person may be permitted. Broadly speaking, an IRA and a disqualified person may have an ownership interest in the same asset so long as the ownership is fairly allocated, is separate, and does not unfairly benefit the disqualified person. The rules can be complex and must be carefully navigated to avoid early withdrawal penalties and negative tax treatment of the IRA, and legal counsel should be sought. Should you have an interest in investing via a self-directed IRA program, please feel free to contact us.