How to Use an IRA to Invest in Real Estate Property
There are several ways to invest in real estate within the framework of an IRA. The first method covered in this article can be done from any type of retirement account, be it an IRA, 401(k) or any other tax-deferred retirement vehicle. It is as easy as buying and selling stock. The second method requires a specific type of IRA account called a self-directed IRA. Within the framework of a self-directed IRA an investor can actually purchase real property, discount paper or a multitude of other non-traditional real estate investments such as hard money lending. The following steps will guide you through the investment process.
Other People Are Reading
Things You'll Need
- IRA
- Self-directed IRA with check writing privileges (if you intend to invest in real property)
Instructions
-
Real Estate Mutual Funds and Real Estate Investment Trusts
-
1
Find the real estate mutual fund most appropriate for your retirement goals. You can research Morningstar rankings, or click the link provided below in the Resources section.
-
2
Buy shares in the real estate mutual fund of your choice just like you would buy any other mutual fund in your IRA.
-
-
3
Understand that Real Estate Investment Trusts (REITs) are Exchange Traded Funds (ETFs). This means that they operate like a mutual fund but trade like a stock. If you input “REIT” into the search engine of your choice, you will find thousands of resources for information regarding this investment vehicle. Included at the bottom of this article is the Forbes Gold List, ranking several dozen of the top REITs.
-
4
Buy shares in the REIT of your choice just like you would buy any other stock in your IRA.
Using Your IRA to Buy Real Property
-
5
Open a self-directed IRA. This is a special kind of IRA that allows you to invest in real estate and other non-traditional retirement vehicles. Enter “Self-directed IRA” into the search engine of your choice and you will find several dozen custodians. Find the custodian with the terms and fee structure most appropriate for your individual retirement goals.
-
6
Transfer all or part of your current IRA into your self-directed IRA. Strict limits exist on the amount of new money you can add to any IRA in any one year, so you will need to transfer all or part of your existing IRA to your new self-directed IRA. Your plan custodian will have all the necessary forms. The process takes two to three weeks.
-
7
Consider buying a property. Now that you have a self-directed IRA with check writing privileges, you can buy property. You are not allowed to take out a mortgage within the framework of your IRA, so you must either pay cash for the full amount of the property or use your IRA to make a down payment and then find a “loan partner” who can get a mortgage. When buying property in your IRA, it is important to remember that all returns (rental income and profits from selling the property) must go back into the IRA. Also, there are restrictions on whom you can do business with if you are using IRA funds. Generally speaking, restricted persons include yourself, your children, grandchildren, spouse and parents. Siblings, aunts, uncles, cousins and step relations are not considered restricted persons according to the IRS.
-
8
Consider buying discount paper. Discount paper is a fancy way of saying private mortgages. Typically, seller financing falls into this category. This can be an attractive alternative for IRA investing as it eliminates all the property management hassles involved in actually owning real property, but it still provides solid returns. For example, if a seller takes a $50,000 note at 10 percent for 10 years from a buyer and then sells that note to you for $40,000 just to get his cash out of the deal, you are now earning $5,000 tax-deferred (because you put it in your IRA) per year on your $40,000 investment, or a 12.5 percent return. You don't have any property management responsibilities but you have the protection of being able to foreclose on the property and sell it again if the buyer stops paying on your note.
-
9
Consider hard money lending (also known as asset-based lending). Hard money lending is a method of real estate finance commonly used by “flippers” and others involved in rehabilitating blighted or otherwise unsatisfactory properties. Due to the condition of said properties, it is difficult to get a conventional mortgage to buy the property and have enough money left over for the necessary repairs. That is where a hard money lender comes in. Hard money lenders loan the money to buy the property and fix it up. They charge what are often considered exorbitant interest rates and origination fees to offset the risk they take lending on sub-par properties. It is not unusual for a hard money lender to charge five origination points up front (5 percent of the overall loan) and 15 percent interest on a loan of six to 12 months. Home rehabilitation investors (flippers) are willing to pay these rates because of the ease of lending and the amount of profit they expect to make when they eventually sell the property.
-
1
