Real Estate is one of the most popular Self Directed IRA investments due to its high growth potential and stable returns. Many investors have come to it after seeing their market-based portfolios fluctuate due to volatile market forces. Seeking relief from these precipitous changes, they turn to investments such as real estate which offer steadier and more predictable account growth. Additionally, many savvy real estate investors want to apply their business know-how to their IRAs.
The IRS allows individuals to invest in real estate, but retirement investors must be careful not to engage in any Prohibited Transactions. The rules do not dictate WHAT kind of real estate one can purchase, but rather WHO the IRA can transact with. The general rule of thumb is that transacting with third parties is allowed while transacting with close family members and closely held entities – referred to as Disqualified Persons – is not. For real life examples and additional information on Prohibited Transactions, please refer to this article: Prohibited Transactions.
Madison Trust has streamlined the real estate investment process, making it easier than ever to purchase real property with retirement funds. Refer to the following step-by-step flowchart for instructions and supporting document requirements:
Things to keep in mind:
When an IRA purchases real estate, title is held in the name of the custodian for the benefit of the IRA: “Madison Trust Company Custodian FBO [Your Name][Madison Account #]”.
Income and Expenses
Income and expenses related to IRA owned property are handled by the IRA custodian and not by the accountholder. For example, accountholders instruct Madison Trust to pay expenses such as real estate taxes and property insurance via an Expense Payment Request. Accountholders deposit real estate income (such as rental payments) directly into their Madison IRA and submit a Deposit Information Form. Alternatively, one can hire a management company to handle the property income and expenses.
One can obtain financing for an IRA investment; however, the loan must be structured as a non-recourse loan. This means that the loan is backed exclusively by property, and not by an IRA holders’ s personal guarantee. The lender’s sole recourse in the case of default is the real property. One cannot personally guarantee a loan issued to their IRA, as doing so benefits their IRA and constitutes a prohibited transaction. Additionally, the loan must be issued by a non-disqualified entity.
Although many investors choose to own real estate directly through their IRA, others choose to invest with real estate companies such as LLCs or real estate funds. In such cases, the IRA takes an ownership interest in an entity, rather than in a real property. The following link offers information on investing IRA funds in a private placement: Private Placements.
UBIT (Unrelated Business Income Tax)
Unrelated Business Income Tax applies when a tax-advantaged entity such as an IRA earns “ordinary” income. In real estate this can take the form of income from multiple short-term property flips. Passive Investments, such as rental income, interest income, and dividend income do not incur this tax. It is best to reach out to an accountant before placing an “active” real estate investment to learn whether or not the tax applies.
Another tax that may apply is Unrelated Debt Financed Income. When an IRA procures a loan for an investment, then the earnings from the financed portion are subject to UDFI.
When either of the above taxes are due, it is the accountholder’s responsibility to prepare Form 990-T. The form is signed off by Madison Trust in its capacity as IRA custodian, and then filed with the IRS by the accountholder.
To learn more about purchasing real property with retirement funds, feel free to contact a Madison Trust Account Executive at 800-721-4900.