Historically, most retirement plans in the United States invest in securities of some kind, but the use of self-directed IRA administrators to facilitate real estate and loan agreements has gained popularity in the last 4 years. This concept is not widely known to real estate or tax professionals, but continuing education classes are available for realtors, CPAs, and other professionals. The result of this is a new source of funds for purchases and development.
Over the past 18 months, there has been a steady increase in the number of Denver business investors placing their IRA/SEP/401(k) retirement plans into real estate through direct ownership, TIC and LLC agreements. Investments have been primarily in upgraded properties such as multi-family and retail stores, but there have also been deals related to construction loans. Many of these investments benefit from the leverage of local lenders.
“Why don’t I know about this?” is the reaction of most investors. The IRS has received this question so often that its website has posted its affirmation of the legality of the concept. “IRA law does not prohibit investing in real estate, but trustees are not required to offer real estate as an option. IRA trustees may place additional restrictions on investments. For example, due to administrative burdens, many IRA trustees IRAs do not allow IRA owners to invest IRA funds in real estate.”
The investor or broker should know that they need a self-directed IRA administrator first and foremost to conduct this type of transaction. Second, the sales contract for these purchases must be initiated by the IRA at the direction of the customer, and all funds must flow through the IRA administrator. Third, there can be no personal use of this property by the IRA holder or close family members, such as parents or children. Self-directed managers may not participate in the investment as promoters or advisers, but must remain completely neutral in the transaction. Fourth, leverage is allowed with some limitations.
The IRA owner can perform due diligence and decisions related to improvements, property management, and tenant selection. Everything from the sales contract to the closing documents is signed by the Administrator, who is responsible for properly granting title and accounting to the IRS for the value of the account, as well as any funds coming in and out of the account. .
Because it is held in a tax-deferred account, proceeds from the sale of an IRA/SEP/401(k) property go directly back into the IRA trust account and are available for the next investment. Subsequent investments may be real estate or anything else permitted by law, with the only investments prohibited by law being life insurance and collectibles. There is no need for a 1031 exchange or any “like” investment to replace it.
Contrary to popular belief, the IRS does not require an annual appraisal of real property within an IRA. While it is true that the value of the account is reported annually to the IRS, there are no specific requirements for an appraisal. Appraisals are only required for a taxable event, such as when a property is taken out of the IRA. All of the rules about investing IRA funds revolve around the issue of self-trading, which is defined as now benefiting from your IRA and transacting with your IRA. The section of the code dealing with “prohibited transactions,” as they are called, addresses these main areas of concern.
As securities become less of a preferred investment and real estate remains a solid investment, retirement plan investment in real estate and notes is expected to continue to grow in the coming years. Realtors and developers can capitalize on this trend by marketing properties for retirement plans and seeking IRA investors in large projects.
