Self-Directed
Real Estate IRA 101
Below is a list of firms we have found that understand
Real Estate IRAs
Equity
Trust Co.
225 Burns Rd
Elyria, Ohio 44035
Sterling
Trust
7901 Fish Pond Road
Waco, TX 76710
PENSCO
Trust Company
450 Sansome Street 14th Floor
San Francisco, CA 94111
Entrust
555
12th Street Suite 1250
Oakland, CA 94607
While you are getting started join a local real estate investors group. One national group is REIClub at http://reiclub.com/real-estate-clubs.php. This web page has links to many local real estate investment groups. Go to the local meetings and talk with other real estate investors.
Establishing an account with a self-directed
IRA custodian is easy and usually takes around 10 minutes to complete by filling
out a simple application.
But before you begin filling out an application,
there are number of things you should review with any potential self-directed
IRA custodian. To help you, below is a checklist of questions you should ask any
custodian before opening an account.
- How long have you been in business?
- What is your fee schedule? Do you have additional fees for certain transactions?
Are there hidden fees?
- How are you regulated?
- How
are you insured?
- Am I working with a branch office/franchise or the main
institution?
- Will there be an account representative to assist me if
I have questions?
- What is the minimum initial investment?
- Do
you offer brokerage services?
- Can I access my account online?
- Answers
to these questions will help you determine the best self-directed IRA custodian
for you.
Completing Paperwork
Once youve
completed your research and selected your self-directed IRA custodian, you must
fill out an application to open an account. As mentioned before, filling out the
application usually only takes around 10 minutes.
Information you will generally
be required to provide includes the following: your name, social security number,
date of birth, address, contact phone number and very importantly your designated
beneficiaries. Beneficiaries are those who will inherit your account in the event
that you pass away.
How long does it take to open an account?
Generally
speaking a self-directed IRA can be opened in 3 to 5 business days.
What
type of accounts can be self-directed?
The simple answer is that with a
truly self-directed IRA custodian any retirement plan can be self-directed.
What
types of retirement plans are available for me?
Often people are surprised
to learn there are a number of government sponsored retirement plans available
to investors. This realization leads to the obvious question, What type
of IRA is right for me?
Many factors help determine what IRA is best
for you including, yearly income, type of employment (self-employed, owner of
small business), financial goals, healthcare expenses and future educational expenses.
The
two most basic accounts are a Traditional IRA and a Roth IRA. These accounts were
designed for individuals and offer tax-free growth on all profits, but there are
differences between them. A Traditional IRA offers a yearly tax-deduction based
on how much you contribute in that year, and a Traditional IRA is subject to taxes
upon disbursement.
With a Roth IRA you are not eligible for a yearly tax-deduction,
but you dont have to pay any taxes upon disbursement. Also, there are income
limits to qualify for a Roth IRA and there are no income limits for a Traditional
IRA. If your yearly-adjusted gross income is above $110,00 (or $160,000 if you
are married), you dont qualify for a Roth IRA.
Certain
Types of IRAs Allow You to Contribute up to $49,000!
In addition to individual
plans, investors can take advantage of the Simplified Employee Pension Plan (SEP)
and the Savings Incentive Match Plan for Employees (SIMPLE). Both plans were designed
for small businesses, but also benefit self-employed individuals.
The SEP
and SIMPLE IRAs allow you to make larger contributions (up to $49,000 in 2006)
than the Traditional and Roth IRAs (only $4,000 in 2006, $5,000 if 50+). Both
IRAs offer tax-free growth on all profits and yearly tax deductions, and all disbursements
are subject to taxes.
New Health Plans Can be Self-Directed
Too...
Government-sponsored retirement plans are also available to help
pay for medical expenses and education costs. You can invest in real estate within
these plans as well.
A Health Savings Account (HSA) is for individuals
with high-deductible health plans, allowing them to set aside funds for medical
expenses now and in the future.
Pay for Your Childs Education
as Well!
The Coverdell Education Savings Account (CESA) is available to
assist in paying for educational expenses.
There are a number of different
types of self-directed IRAs available that allow you to invest in real estate,
and depending on your financial goals, youll want to take advantage of more
than one of these plans.
You can also roll over any existing 401(k)/403(b)
plan to a self-directed custodian as well.
Funding Your IRA Through Contributions
There
are two basic ways to put money into your newly established self-directed IRA:
an out-of-pocket contribution, or a transfer/rollover.
These funding processes
are simple, but you should be aware that each process has its own unique requirements.
Below youll learn what process youll need to fund your account, what
materials youll need and how long it will take to get your account funded.
To
make an out-of-pocket contribution to your self-directed IRA, you must meet two
basic requirements. You must be alive (if you are reading this, you qualify!)
and have earned income in the year you plan to contribute.
Eligible
Income:
Earned income includes: wages, tips, bonuses, and other compensation
reported in Box 1 on your IRS Form W-2. If you are self-employed, earned income
is your share of net income reported on your IRS Form 1040.
Passive
Income Not Eligible:
Many Americans receive multiple sources of income,
such as rental income. But some income isnt considered earned income, including:
passive income like earnings and profits from property, interest or dividend income,
foreign income, annuity income and deferred compensation.
What
can I contribute annually:
What you can contribute annually depends
on which type of IRA you have established. Below is quick list of the contribution
limits for 2006. As mentioned early ANY IRA can be self-directed including the
plans listed below.
IRA
Plan | Contribution
Limit (Employer) | Contribution
Limit (Indivdual) | Catch
Up (over 50) |
Roth/Traditional
IRA | N/A | $4,000 | $5,000 |
SEP IRA | up
to $44,000 | up to $44,000 | N/A |
SIMPLE IRA | 1-3%
of compensation | $10,000 | $12,500 |
401(k)/403(b) | 0-25%
up to $44,000 | $15,000 | $20,000 |
Roth 401(k)/403(b) | 0-25%
up to $44,000 | $15,000 | $20,000 |
How do I actually get the money in the IRA? Do
I need any paperwork?
This is the easy part. In order to make a contribution,
send funds to your self-directed custodian in the form of a check, money order,
cashier's check, wire or by credit card.
You will need to send attach a
form to your funds designating the correct tax-year for your contribution.
I
know there is a maximum contribution, but is there a minimum amount I need to
contribute now?
It varies among custodians, but generally most self-directed
IRA custodians have a $200 minimum contribution.
How to Transfer/Rollover
an Existing IRA to a Self-Directed IRA
Another way to fund a new self-directed
IRA account is through the transfer-in or rollover processtaking
an existing IRA and transferring it to a self-directed IRA. While there are some
slight differences between a "transfer-in" and a rollover, both IRA
funding methods are essentially the same.
IRA funds
must be transferred between like accounts:
When transferring IRA funds
between custodians, the IRAs must be similar accounts. For example, transferring
an existing Traditional IRA to a new self-directed Traditional IRA, or a Roth
IRA to Roth IRA.
What type of paperwork do I need
to fill out during the transfer process?
After completing your new self-directed
IRA application, you'll fill-out a account transfer form. The transfer form must
be signed by you and by your new custodian. The form will be sent to your current
custodian to initiate the transfer.
Youll also need to include a
copy of your most recent statement when submitting the transfer form.
Do
I have to transfer all of my money from my current IRA to my new self-directed
IRA?
Absolutely not. You can transfer as much as or as little as you
want.
After completing the transfer forms, you select the amount you want
to transfer and have your current custodian wire the money or write a check to
your new self-directed IRA custodian. Remember to make the check payable to your
IRA, not you. Below is an example:
Your IRA Custodian For Benefit Of
"client name" IRA
Do I pay taxes when
I transfer from my current custodian to a self-directed IRA custodian?
No.
A transfer from an existing IRA to a self-directed IRA is not a taxable event.
The exception is when converting an existing Traditional IRA to a self-directed
Roth IRA. (See below.)
I already have a Traditional,
but I really like the idea of having a Roth IRA. Can I transfer from a Traditional
IRA to a Roth IRA?
If you wish to convert funds from a Traditional to
a Roth during the transfer process, you can.
The transfer-in process (as
stated earlier) is only allowed between accounts with similar tax-benefits (like
a Traditional IRA to a Traditional IRA or SEP to a SEP). You can transfer a Traditional
to a Traditional and simultaneously covert it to a Roth, but this is a taxable
event and you will pay taxes on the amount transferred.
Do
I have to liquidate all of my assets before I transfer my funds?
Absolutely
not. You can liquidate some of your assets or none at all, and may choose to rollover
your assets in kind. An "in-kind" direct rollover allows you to maintain
your current investment positions, the only difference being the registration
of the asset.
I am ready to get started right now,
how long does the process take?
The transfer process can take up to
28 days, depending on the processing time of your current custodian. For qualified
plans (like 401(k)) it takes between two to four weeks depending on the current
custodian.
Example of a Self-Directed Real Estate
Investment
I've Found An Investment Property, What's Next?
After youve found a property to purchase, you need to fill out a
Direction of Investment (DOI) form. This form tells your self-directed IRA custodian
the specifics on the property youd like to buy, how much money you need,
and where to send the funds.
Investment Must be "Arms
Length"
Remember when searching for investment property that your IRA
cannot purchase from a "disqualified person." A disqualified person
includes you and your family members of lineal descent. Investments using your
IRA should be "arms length."
Also, you cannot receive an indirect
benefit from the property purchase. You aren't allowed to use a vacation property
that your IRA owns or rent personal office space from your real estate IRA investment.
Additional Documents You'll Need to Complete the Investment
In order for a self-directed IRA custodian to process your DOI they need
additional documentation verifying the property sale. Examples of proper documentation
include purchasing agreement, HUD statement, a sales contract, etc.
In
addition, documents should include your self-directed IRA custodians tax
ID number instead of your personal social security number. If you are unsure of
your custodian's tax ID, please contact them before sending in the documentation.
Ensuring Proper Titling: You and Your IRA are Not the Same
One of the most common mistakes (and cause of delays) in real estate IRA
investing is when the property is titled incorrectly. Before a title company draws
up documents, make sure you notify them of the proper titling. Frequently the
IRA owners personal name is incorrectly put on the title of the property.
Remember
you and your IRA are two separate entities, and as such, the property needs to
be titled in the name of your IRA and not you personally.
The correct title
for most real estate IRA investments is:
Your IRA Custodian FBO (for
benefit of) YOUR NAME IRA
Preparing for Closing
Youve
filled out the DOIs and titled the documents properly, now you are ready
to close. Closing documents, which are prepared by a title company, are forwarded
to your self-directed IRA custodian to be signed on behalf of your IRA.
Funds
Remitted From Your IRA
With everything in place, funds will be remitted
(via your self-directed IRA custodian) to the title company for your investment.
Funds can be remitted by check, money order or, the most popular option, bank
wire.
How Long Will This Take?
Processing times
can vary with self-directed IRA custodians. It usually takes 3-5 business days
for regular processing. If you need to close a deal fast, expedited service is
usually available and your documents may be able to be processed the same day.
After
the closing and the sale is final, the last step is to send original documents
to your self-directed IRA custodian for safekeeping.
Your
IRA Owns the Property!
You now own a property with your self-directed IRA!
After following the simple steps above you are ready to enjoy tax-free profits!
What Happens After You Purchase A Property With Your IRA?
Once
you've purchased a property you need to decide if you will manage it or if you
will hire a professional management firm. If you choose a professional management
firm, they will handle all of your property's income and expenses for you.
But,
if you plan to manage the property on your own this will detail the two main parts
to managing your investment--how to deal with expenses like property taxes, maintenance,
and utilities, and how rental income actually gets back into your account .
Paying
Property Expenses Out of Your IRA
IRA Responsible
For Expenses
A self-directed IRA investment property is just like a
property outside of an IRA. From time to time youll need to pay for things,
like property taxes, maintenance, or upgrades to the property.
The IRA is
responsible for paying expenses related to the asset it owns. You cannot make
these payments personally.
Paying For Expenses Simple
Process
For expenses, you will need to complete a Bill Pay Direction
of Investment (DOI) form and submit supporting documentation such as a bill, receipt,
or invoice. This form tells your self-directed IRA custodian how much money is
needed and where they are to be sent.
With some IRA custodians you can make
expense payments under $1,000 completely online!
Re-Occurring
Expenses Can Be Paid Automatically
If your property has re-occurring
bills (such as an association fee), they can automatically be paid on a schedule.
Rental/Mortgage Income in Your IRA
Getting
Income From Your IRA Investment Property Back to Your IRA?
Once your
real estate investment starts to generate cash flow you will need to ensure that
it gets back to your IRA in proper form.
To properly deposit those funds
into your self-directed IRA, youll need to first make sure the payment is
titled correctly.
Payees Must Make Payments to Your
IRA: Proper Title A Must
Similar to correctly titling for your property,
you need to ensure payments are made out to your IRA, NOT to you.
Remember
you and your IRA are two separate entities, and as such, payment checks need to
be written to the name of your IRA and not you personally. The correct title for
most real estate IRA investments is:
Your IRA Custodian FBO (for benefit
of) YOUR NAME IRA
Variation For Privacy Purposes
Some
IRA owners do not want tenants/payees to know who owns the account. If this is
a concern for you the solution is quit simple. The payee is instructed to title
checks the same way as above with one exception, the IRA owners name is replaced
with the IRA owners account number. For example:
Your IRA Custodian FBO
(for benefit of) IRA #12345678
Documentation
Needed For Income
In addition to correct title on checks, a deposit
coupon is required for all funds deposited to your self-directed IRA. The coupon
is created by your custodian and given to you to submit back to the custodian
with payment.
The deposit coupon must accompany the submitted checks by
either you or the sender of the check. Similarly, a deposit coupon must be faxed
or emailed to your custodian if funds will be wired.
Making
Sure Rental/Mortgage Payments Are Made
Rental/Mortgage payments received
by your custodian are deposited immediately into a interest bearing account. Most
self-directed IRA custodians have online account logins, which allow you to monitor
payments deposited into your account 24 hours a day, seven days a week without
having to pick up the phone.
Good Funds Available
to You Faster
Now that you have funds coming into your account, a question
you might ask is when are those funds available for reinvestment?
Personal
checks have a holding period to ensure they are good funds, i.e. the checks do
not bounce. Funds are available to you the same day if submitted by cashiers
check, money order or wire.
How To Sell An Investment In Your IRA
Starting
The Sales Process: A Simple Example
At some point after purchasing real
estate with your self-directed IRA, you may want to sell the property.
Let's
assume you've purchased a home 10 years ago with your self-directed IRA for $100,000
and now you've found a buyer* willing to purchase the house for $200,000.
*Remember,
as when purchasing real estate in your self-directed IRA, you should only sell
the real estate in an "arms length" fashion. You may not sell property
in your IRA to yourself, family members or any other "disqualified person."
Working With A Title Company: What You Need From Them
Before funds
can be remitted to your IRA from the sale, you must complete the sale process
through a title company. The following are examples of documents the title company
may require to complete the sale: