A real estate investor from Illinois, Rex ,purchased a foreclosed home in 2013 for $47,000 (including some rehab costs). After renting it for a year, he sold the property for $69,000. While profitable, this real estate investment stands out because Rex (a client of my company’s, Equity Trust) used a self-directed IRA.
The investment was a win/win: Rex earned the profits tax-deferred in his retirement account and his investment helped a family remain in their home of 40 years.
What Is a ‘Self-Directed’ IRA?
It’s estimated that fewer than five percent of IRA investors use their retirement plans for more than stocks, bonds and mutual funds, though.
Self-directed IRAs can invest in those traditional places as well as in a much wider range of investments, such as real estate, private loans and other “alternative” assets.
The contribution and tax deduction limits set by the IRS each year, as well as other account characteristics like eligibility and distribution requirements, are the same for all IRAs — “self-directed” or otherwise.
There are certain investments the IRS doesn’t permit for an IRA, however, such as collectibles (artwork, stamps, antiques and the like), life insurance and certain coins. It’s important to consult with your tax attorney or other financial professional before investing in a self-directed IRA.
Only certain financial institutions support the increased investment flexibility of self-directed accounts, however. (Full disclosure: Equity Trust is one such custodian.)
How a Self-Directed IRA Investment Works
While there are limits on the amount of out-of-pocket contributions made to an IRA in a given year ($5,500 for those under 50 in 2018; $5,500 for those 50 and older), there are no limits on the amount that can be rolled over or transferred from an existing retirement account (such as a 401(k) or existing IRA) to a self-directed IRA. Nor are there limits on the amount that can be nvested from the account.
To purchase real estate in a self-directed IRA, funds come from the IRA and, once settled, the IRA owns the property — not the investor. Once the IRA owns the investment, all expenses related to the investment are paid from the IRA and all profits, which are tax-advantaged, go directly to the IRA.
When investors use their IRA capital to invest in real estate, private loans and other alternative assets, they have the potential to assist communities in a tangible way.
Below are two more examples.
Investing With Community Impact
After the housing crisis of 2008, many homeowners were stranded with underwater (or upside down‚ mortgages — owing more than the homes were worth. Neighborhoods were destroyed and many families lost their homes to foreclosure.
But that’s how investors like Rex have helped. Before buying it for his IRA, he drove by to take a look. Next to the entry, he saw a plaque bearing the family name. “It was sad, looking at that proud plaque knowing this family’s home was in trouble,” he said.
After leaving his card at the door, Rex received a call from the homeowner who explained her home went into foreclosure after her died. Rex told the homeowner he intended to bid on the home, but she could stay another month rent-free until his IRA completed the purchase. After his IRA won the bid, Rex worked out an agreement with the homeowner’s daughter, Katie, who recently moved back into town.
Katie met with a lender to create a Credit Improvement Plan and worked with Rex to establish a Rent-to-Own agreement: She’d pay Rex $650 a month (the money was returned tax-deferred to his IRA) and Rex provided a small personal loan to help Katie pay off medical bills and a past collection.
Eventually, Katie purchased the home from Rex’s IRA for $20,000 less than market value. Rex’s IRA earned a 65-percent return on investment (ROI) and Katie became the new owner of the family home.
“Katie said she thought this would never happen. But today, the family owns their home again,” Rex said. “The home is repaired and good to go for another generation,” he said. After nearly 300-plus real estate transactions in his career, Rex said this was his most fulfilling.
Post-Hurricane IRA Investment in New Orleans
Here’s another example: A few years after their community was ravaged by Hurricane Katrina, a couple from New Orleans pooled their self-directed IRAs to help an investor rehab a flooded-and-gutted home. They invested $106,000 between their two accounts, along with an additional $12,000 the rehabber put in. The funds were used to buy and renovate the home, as well as paying its carrying costs.
Four months later, the rehabbed house sold for $235,000. The couple’s IRAs received 33 percent of the sale price, which was returned tax-free to their Roth IRAs.
IRA Investor Helps American Vets
One more example: Another self-directed IRA investor, Roger from Maryland, helped his friend Bob, a pastor and Vietnam veteran, fulfill a dream — establishing a group home to support veterans suffering from post-traumatic stress disorder.
After bank financing for the property fell through, Bob feared his dream would not come true. Roger stepped in and provided a $100,000 loan from his retirement account, so Bob could acquire the property. The 6-percent interest returned to Roger’s retirement account tax-deferred. But Roger says the real payback was making the veterans’ group home a reality.
“If I wasn’t able to step in and use my self-directed IRA funds as the initial financer of the house, I believe the transaction would have fallen through,” he says.
It’s important that self-directed IRA investors understand the intricacies and risks and work with a team of professionals to ensure their financial decisions fit into a cohesive retirement plan. But, for the community-minded investor, self-directed IRAs could offer an opportunity to grow your retirement nest egg and help your community at the same time.
Disclaimer: The above case studies are for educational purposes only. Past performance is not indicative of future results. Investing involves risk, including possible loss of principal. Information included in the above case studies was provided by the investors and included with permission. Equity Trust Company does not independently verify all information provided by third parties.
Equity Trust is a passive custodian and does not provide tax, legal or investment advice. Any information communicated by Equity Trust is for educational purposes only, and should not be construed as tax, legal or investment advice. Whenever making an investment decision, please consult with your tax attorney or financial professional.
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