How to Leverage a Retirement Plan

Leverage your IRA with real estate investments.

Leveraging a retirement plan can be tricky if you don't know what you're doing. While an employer-based plan such as a 401k allows you to take a loan against the account, you may not use retirement assets as collateral. In fact, loans are not allowed in IRA assets and if you try to leverage an IRA with a short sale, the IRS considers the entire IRA distributed. But there is a way to leverage your retirement account that most investors are not aware of. It involves the self-directed IRA.

Instructions

1. Open an account with a self-directed IRA custodian. Ask about the types of investments allowed in the self-directed IRA, the fees and the reporting duties. The IRS allows equity investments, investment real estate and private stock purchases. Not every custodian allows all the IRS-accepted options. Entrust Group and Pensco are two custodians that allow diverse investment options.

2. Fund the account. Transfer assets from an existing IRA or 401k into the new self-directed IRA. Of course, having more assets opens the door to different opportunities, but since you will be leveraging the IRA, you don't need to have an extremely high balance. This means you could fund the IRA with just an annual contribution.

3. Open an LLC (limited liability company). Write an agreement between the IRA and the LLC. If you are familiar with legal documents, you may be able to do this yourself. But beware: Improperly setting up the companies can lead to significant tax penalties. Hire an attorney or a tax adviser when in doubt.

4. Obtain a mortgage for the investment property through the LLC. Find a lender experienced in these transactions.

5. Buy the investment property. Transfer title to the IRA.

6. File IRS Forms 990-T and 5498. These forms are used to deal with the debt and income from the property and the relationship between the LLC and the IRA.

7. Maintain the property as an investment. Any personal use of it will result in tax penalty. You cannot rent it to family, use it as a vacation home or even put sweat equity into repairs.

Tips & Warnings

• Consult a tax adviser to make sure you are complying with all regulations regarding self-directed IRAs. Failure to do so may result in significant tax penalties or loss of assets.

References

• Investors United: Tax-Free Profits with Self-Directed IRAs?
• IRS: FAQs about IRAs