Advice on Using IRAs for Investing In Real Estate

The Mortgage-Pro · Site Admin Joined: 19 Jan 2005 Posts: 2248

Strategies for Using IRAs To Invest in Real Estate
By RAY A. SMITH
Special to RealEstateJournal.com

Last month in The Wall Street Journal, I wrote about a way to invest in real estate without having to own or manage a property, while earning tax-exempt or tax-deferred income from that real estate. The strategy involved using an Individual Retirement Account (IRA) to buy or create mortgages.

Here's an example of how such a transaction can work: A seller of a property would create a mortgage or note. These notes usually are created between individuals, not traditional lenders. The borrower/buyer would make the monthly payments plus interest to the seller. The property seller would then sell that mortgage to an investor for cash upfront, often at a discounted price. The investor would buy the mortgage through his or her IRA and would earn income through the interest on the mortgage as well as the difference between the actual mortgage amount and what the investor paid -- all without having to own the actual property or manage it.

The investor would normally have to pay tax on the income earned. But with an IRA, the investor would defer or wouldn't have to pay taxes on that income. Profits gained from investments aren't taxed in a traditional IRA until the money is withdrawn. And withdrawals from a Roth IRA are tax-exempt, provided the individual is 59½ or older and has the Roth IRA open at least five years.

The steps to doing this are generally as follows. An individual with a self-directed IRA must first conduct a transfer from his or her account to an independent custodian that offers real estate as an investment option. Once the individual finds a mortgage to buy or create, he or she signs a direction letter, a form that instructs the custodian to buy or create the note.

A number of readers had follow-up questions. Here are some of their questions, and answers from professionals.

Question: How do you find the custodian so that you can buy real estate and mortgages? What kind of annual fee is typical for these services?

-- Herb, Los Angeles

Herb: Dyches Boddiford, a real-estate investor based in Atlanta, says you many want to ask your local banks if they will let you buy these investments in an IRA. He also adds that there are quite a few smaller regional banks that will do this. He recommends these national companies if you can't find a local one: Wells Fargo & Co., Equity Trust Co., Entrust Administration Inc. and Pensco Trust Co.

Fees can vary, but Patrick W. Rice, president of IRA Resource Associates Inc., a Camas, Wash.-based advisory firm specializing in real-estate investing for IRAs, says typically you will pay less than 1% of the asset value annually.

Question: With an IRA, can you buy the real estate outright? I'm thinking of investing in a model home. The developer will do a sale-leaseback with me. I don't need to borrow the money to purchase the home. Can I just buy the home outright?

-- Chris, Scottsdale, Ariz.

Chris: Yes, you may purchase the home and use it as a rental, according to Mr. Rice. In this case, all net income goes into the IRA. All expenses come out of the IRA.

-- Mr. Smith is a staff reporter for The Wall Street Journal.