By: Jeffrey Dixon, MBA, CISP, SDIP
When you found out were you surprised that your Self-Directed IRA or Solo 401k can buy and own physical real estate property? A lot of people are! Before you get started, it is important to understand the process to avoid mistakes or time delays.
Opening the account:
The Self-Directed IRA should be already set up and funded. If you wait to open the account until you find a property, that can cause delays. It can often take 2-6 weeks for the funds from another retirement account to be moved to the new account with us.
Looking for the property:
Who finds the property the IRA will be purchasing? Answer is – You! Be sure to follow the rules and avoid prohibited transactions. Don’t choose a property that you or a prohibited party already own. You will negotiate the purchase price.
The Sales Contract:
The Self-Directed IRA is the purchaser. Your IRA will have a name that is listed as the buyer on the sales contact. The name we use is (Client’s first and last name), legal owner via non-trust custodial IRA with AET. Solo 401k’s use a name the client chooses for the plan. It may be something like Acme Hardware 401k Plan. You will sign the contract. You cannot assign a contract that you have entered into personally. If you do that, that contract will need to be voided and any personal money you have provided must be returned to you.
Earnest Money:
Who makes the earnest money deposit? If you have to give the seller a deposit or earnest money, that comes from the Self-Directed IRA. We send the money. You cannot write a personal check for anything related to the house purchase. Send the contact to your custodian to review along with a Direction of Investment (DOI) form.
Financing:
Can an IRA borrow money? Yes! the IRA can use financing. Just as the IRA is the buyer, the IRA borrows and repays the money to the lender. The only loan the IRS allows is a non-recourse loan. Non-recourse means that the lender can only foreclose on the property if the IRA is in default. You cannot give a personal guarantee for the loan. Most lenders will not agree to make a loan to an IRA. We keep a list of lenders that will and will send it to you if asked. We have to review the loan documents.
There is a tax called Unrelated Debt Financed Income (UDFI) that your Self-Directed IRA will be subject to when financing is used. The Solo 401k is generally exempt to this tax.
Closing on the property:
The closing agent will draw up a settlement statement. This will list all the costs of the purchase. That needs to be sent to us for review. You will sign all the purchase documents, including the loan documents. You and the seller have to sign our Hold Harmless forms. We will wire from the Self-Directed IRA or Solo 401k to the closing agent. Title for the property is now in the name of the Self-Directed IRA.
Costs, Repairs: and Rent:
The IRA must pay for any cost the property incurs. To make sure the IRA is sufficiently funded, we require the IRA have a 10% cash cushion left after closing. You can never pay any of these costs yourself.
So who does the repairs on IRA-Owned properties? The work must be done by a third party. You or a prohibited party cannot do any work on the property. You can decide who will do the work.
Rents are made to the IRA. The money can be sent by check or wire. The money can never be made payable to you. You could pick up a check made payable to the IRA and mail it to us. If the tenant wanted to pay using cash, they would need to get a cashiers check made payable to the IRA.
Final Thoughts:
Consulting a tax professional is a very good idea before making any decisions. Feel free to contact us if you have questions about this or any IRA-related topic. We can be reached at (866) 402-2781 or info@uDirectIRA.com.
