By Diana Hill, Online Trading Academy Real Estate Investor Instructor
One of my favorite moments in the real estate workshop is when I inform students that they could be using their Self-Directed Retirement Plan (SDRP) to invest in real estate. The first question always is, "What is a Self-Directed Retirement Plan?" - The term "self-directed" simply means that you, as an individual, have complete control over selecting and directing your own individual retirement account or 401k investments. The next question is, "How can I invest in Real Estate?" - Either directly by purchasing and maintaining property or indirectly by making loans to others buying real estate. There are over $4.2 trillion dollars in the retirement market today, only 2% of that is currently self-directed, however, it is among the fastest growing segments. An SDRP allows access to a variety of investment vehicles, not just stocks and bonds. The IRS closely regulates Self-Directed plans; therefore, real estate investments purchased and held in those plans must be handled properly. People who invest in real estate through a self-directed plan must make sure they adhere to the IRS rules and use a custodial firm.
So, for example, Jake Astor decides to use his SDRP to purchase a dilapidated single family house in Ferndale, MI, for $32,000 in cash. He uses another $15,000 from the retirement account to go towards renovation and fix up. From his research, he knows the property will rent for $950 a month and that money goes straight into his retirement account. I asked Jake what makes this such an attractive investment for him. He responded by saying, "The rental income goes into my IRA which is tax deferred income. Then, once I sell the property, the profit also goes directly into my IRA without capital gains. Say I hold the property for 5 to 7 years, it will probably be worth $100,000 to $125,000. That’s a sizable profit. The Self-Directed IRA is a great long-term investment tool."
Here is a four step action plan to create your SDRP and invest it in real estate:
- Find a custodian that you feel comfortable with that has a good reputation. Determine what SDRP is best for you and complete the adoption agreement.
- Fund your new SDRP by either the allowable amount of contribution or by rolling over an existing plan. You can either do a direct rollover, which moves funds from an existing retirement plan directly into your new SDRP, which means you never take possession of the funds, so no taxes will be withheld. Or you can elect a 60 Day Rollover which allows you to take possession of the funds but the funds must be placed in a new SDRP within 60 days or they become a taxable distribution.
- Identify a real estate investment for your SDRP.
- Complete a buy direction letter for the investment.
Here are some of the most frequently asked questions that arise when people are considering real estate as an investment in their SDRP:
What are the differences between buying real estate for myself and purchasing real estate in my SDRP?
- Title –when purchasing an asset for your SDRP, it must be properly titled to your plan; for example, "Equity Trust Company Custodian for the benefit of (your name) IRA."
- Funding – when purchasing an investment (or any portion of an investment) for your SDRP, the funds must come directly from your plan. They will be sent by your custodian directly to the Title Company/closing agent or attorney per your instructions.
- Expenses and income – any expenses associated with your SDRP investments must be paid for out of the plan and any income must be paid into the plan.
- Signatures – documents pertaining to your SDRP investments must be signed by the custodian on behalf of your plan.
Can my SDRP purchase real estate I currently own?
- No. This is considered a prohibited transaction (see IRC 4975). You may not purchase property or an interest in property that's currently owned by a disqualified person (this includes you and family members of lineal descent).
What can't I buy with my SDRP? IRS Publication 590 lists only three areas of investments your plan is prohibited from purchasing:
- Life Insurance
- S Corporations
- Collectibles
This is just a small example of how you can diversify your portfolio by using an SDRP. By using these plans, you can buy larger and more expensive investments, more profitable investments and create a family legacy. Future articles will explore how you can partner with your SDRP to purchase real estate and benefit today.
Hope to see you in a class soon.
Great Fortune!
- Diana Hill
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