Historically, most retirement plans in the United States invest in securities of some sort, but gaining popularity over the last 4 years is the use of self-directed IRA administrators to facilitate real estate and lending deals. This concept is not widely known by either real estate or tax professionals, but continuing education classes are available to real estate brokers, 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 commercial investors placing their IRA/SEP/401(k) retirement plans in real property via direct ownership, TIC arrangements, and LLCs. Investments have mainly been in improved property such as retail and multi-family but there have also been deals involving construction lending. Many of these investments benefit from leverage from local lenders.
“Why don’t I know about this?” is the reaction of most investors. The IRS has received this question so frequently that their website has posted their 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 are permitted to impose additional restrictions on investments. For example, because of administrative burdens, many IRA trustees do not permit IRA owners to invest IRA funds in real estate”.
The investor or broker should know that first and foremost, they need a self-directed IRA Administrator to do this type of transaction. Secondly, the sales contract for these purchases needs to be initiated by the IRA at the client’s direction, and all funds must flow through the IRA administrator. Third, there can be no personal use of this property either by the IRA holder or close family members such as parents or children. Self-directed administrators are not allowed to be involved in the investment as either a promoter or an advisor but must remain completely neutral in the transaction. Fourth, leverage is permitted with some limitations.
Due diligence and decisions regarding improvements, property management and tenant selection may be performed by the IRA holder. Everything from the sales contract to the closing documents are signed by the Administrator who is responsible for the correct vesting of title and accounting to the IRS on the value of the account as well as any funds traveling into, and out of, the account.
Because it is within a tax-deferred account, the proceeds of the sale of property owned by an IRA/SEP/401(k) go directly back into the IRA trust account and are available for the next investment. Subsequent investments can be real estate, or anything else allowed by law, the only statutorily prohibited investments being life insurance and collectibles. There is no need for a 1031 exchange or any “like kind” investment to replace it.
Contrary to popular belief, an annual appraisal is not required by the IRS on real estate within an IRA. Although it is true that the account value 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 rules about investing IRA funds revolve around the issue of self-dealing, which is defined as benefiting now from your IRA, and having transactions with your IRA. The code section dealing with “prohibited transactions,” as they are called, address these main areas of concern.
As securities become less the investment of choice, and real estate remains a solid investment, it is expected that retirement plan investment in real estate and notes will continue to grow over the next few years. Real estate brokers and developers can capitalize on this trend by marketing properties to retirement plans and seeking IRA investors in large projects.