By: uDirect IRA Services Business Development Manager, Jeff Dixon
I talk with many people every week about investing in real estate with their IRA . There are some specific rules to follow when an IRA does invest in this asset class. Unfortunately, not everyone follows these rules and it can create problems and add delays to the transaction.
First, the main thing to keep in mind when investing your IRA this way is that the real estate is purchased in the name of the IRA, not in the account holder’s individual name. The contract cannot be assigned to the IRA either. If the account holder submits an offer in their personal name, the contract is not usable for the IRA transaction.
Second, all money for the deal must come from the IRA account. The account holder cannot use personal funds. This includes earnest money and any inspections. You cannot simply request a reimbursement from the IRA funds. Using personal funds or co-mingling funds when investing your IRA can lead to a prohibited transaction for “receiving personal benefit”.
Third, when these things occur, the only way to correct the problem is to void the original contract and then start over with a new contract. It is possible the seller will agree to start over, but they may not. That is why it is best to set up and fund a self-directed IRA before you start looking for an investment property.
Fourth, people often want to use financing when their IRA is investing in property. This is allowed by the IRS. However, there are rules to follow.
Just as the property is bought in the name of the IRA, the loan is made to the IRA. It must be a non-recourse loan, which means that if the lender has to foreclose, all they can do is take the property back. They cannot go against any other assets in the IRA or the account holder. The account holder cannot personally guarantee the loan for the lender. You will find that most banks and mortgage companies do not make loans to IRA’s. There are lenders who will make these loans. It is generally private companies and hard money lenders. The interest rates are higher and the down payments are larger than most companies permit individuals to obtain. If you would like a list of non-recourse lenders we can send one to you. This is not a list of companies we endorse. Rather it is a listing of companies for your convenience.
Fifth, when financing is used, a tax may be assessed against the IRA. It is called Unrelated Debt Financed Income tax (UDFI). The percentage of the deal that was financed may be taxed. This is an area you need to discuss with your tax advisor to make sure you are aware of how this may impact you.
If you follow the rules, buying real estate with your IRA can be a simple process. And we are always here to answer questions for you and guide you every step of the way.