Clever real estate investment funding you must know about
The most creatively funded investment I worked with.
One of the best things about working with investors is I get to not only educate, but I too get to learn from other investors who have specialized knowledge. I recently helped an investor buy a property within her IRA. What she purchased was a single-family home, to be renovated, and then rented out for a buy and hold investment. Up till this point it is a typical investment, right? But how she funded it was something I have never seen in my 35 years of investing and was very lucrative.
What she did was financed a partnership with herself, as a non-qualified person- and her IRA. I will get into that in the final few paragraphs but first it is important to know how to buy a property with a self-directed IRA.
Creative funding with Self-directed IRA’S
Now investing in Real Estate using self-directed IRA funds is not a new concept. It has been around a while now. Interestingly enough, the vast majority of people who own a qualified retirement account do not know that they can self-direct where the IRA invest its funds. Yes, instead of your funds being invested in the latest unknown tech stock or companies that you do not know or perhaps do not believe in, you can actually direct what the IRA invests in, pretty cool a-ha. How it can be that such a powerful investment tool is such a secret to the majority of people who has them? Savvy investors have been doing this for years and making some huge profits for their personal retirement. So, let’s remove this secret and introduce to the masses where clever investors are making bigger returns for their retirement funds.
How to utilize your qualified IRA for real estate investing
Millions of people have been working over the years where your employers have been contributing money into your retirement account. Often you could place a percentage of your paycheck or a chosen dollar amount and contribute that money into a retirement account. Better yet many companies offered you a matching dollar amount to contribute into you retirement account. These retirement plans are controlled by your employer as long as you are employed with them. What happens when you are not yet at retirement age but you have left the company? Well, you have options. Lots of options.
This is where the magic happens
As you leave a company that you have a retirement account with, the nature of contributions to that account changes. Often the company you left will let your money sit quietly while they manage it for you, however they default. For a fee, of course. Or they guide you in moving these funds into a different retirement account. The latter is less common, as corporations would love to keep making money on managing your money, especially with the stocks they get to choose for you. However, you have a variety of options as to where you can send your money. There are rules that need to be followed to make sure that you do not personally take possession of this money without tax consequences (after all it is in place for your retirement). You can send the money into any number of retirement brokerage accounts to manage these funds for you and keep the money in compliance with IRS rules and regulations. One of these options is the Self Directed IRA- a custodian that allows YOU to direct where the funds are to be invested, as described by its name.
Self Directed IRA
When you move your funds into a self-directed IRA you are basically moving it into an account where you have a company playing the role of a custodian. They take care of handling all the paperwork to keep your IRA (Self Directed Retirement account) in compliance with IRA rules and procedures. You then can decide what you want to invest in. Put simply, the custodian is the bookkeeper and record keeper between you and the IRS.
For millions of people they choose to invest in Real Estate. In fact there are a number of investment vehicles that you can invest in. precious metals, Real Estate Notes, Mortgages, Buy and hold real estate investments, wholesale real estate investments. Fix and flip investing as well as many others. The point is it you have some basic or perhaps thorough knowledge of real estate or maybe just a passion for real estate you can join the millions of savvy investors who control their own financial destiny be investing their retirement accounts into real estate.
Who do you trust with your money more than you yourself?
Do you know that many people who invest in stock market are actually investing in real estate? Yes even Wall Street understands that real estate investing is one of the best and safest investment vehicles around. So when you go to an investment broker they take your money and often a large portion of your dollars ends up investing in real estate. By eliminating the middle man who wants to make the lion’s share of the profits, you may indeed personally direct your investment dollars into real estate.
The workflow of a Self Directed IRA
Now for the purpose of this illustration we are going to keep this simple. The illustration is not listing every income and expense in owning a property but instead providing a basic outline:
Roll your retirement account into a self-directed IRA account. Let’s assume you have 200,000 dollars in your account.
You find a house that you want to invest in. Let’s say you buy a house for $100,000.
You buy the house by writing a contract in the name of the IRA. So the IRA is actually the buyer and you are the owner of the IRA.
Assume you have $1000 per month in cash flow after expenses. Your property manager sends the $1000 back to the IRA Company and this $1000 goes back into your Self-directed IRA account. So after 100 months of consistent deposits into your account you essentially now have $100,000 returned back to your account. Now you have the same as you started with and each additional deposit the funds grow beyond that point. Meanwhile the IRA still owns the hard asset (the house), which now has grown in value and is also an asset to your IRA.
When expenses arise, the bill gets sent to your Self Directed IRA custodians and they pay the bills from your account on your behalf after you approve the bill
When you sell this house the funds also go back into your IRA. In other words, your IRA can benefit both from the cash flow and the market equity growth.
The nice thing is all the funds and accounting is done by the custodian of the IRA for fixed fees and often can be thousands or tens of thousands of dollars less than paying brokerage accounts for typical investment trades.
But wait! Here is where we can get more creative in the area of funding.
What if your IRA has only (let’s say) $50,000 dollars and you want to buy a $100,000 property. There are creative options for this as well.
1. You can finance within your IRA. Lenders require at least 25 to 30% (sometimes more, for non-warrantable products) for a down payment and if you can cover that you are ready to start investing.
2. You can partner with another investor. Many investors team up to buy investment property.
3. Partner with yourself: As I mentioned above this investor who had much more knowledge at the time than I did actually partnered with her IRA to purchase a property. Her IRA that was owned by her is considered a separate entity, complete with a separate tax ID number. As the beneficiary of the IRA she cannot be joint tenants with the iRA, as this would be considered co-mingling. She can, however hold title as tenants in common (percentage ownership partnership) with her IRA.
So, she purchased this property in partnership with her two separate entities. She bought a portion herself, and in this case, she purchased 20% of a property in her own personal name. She then purchased 80% of this property with funds from her IRA so she has a 20/80 partnership stake.
The benefits and liabilities pay out in those same percentages until she is of retirement age, Pretty creative huh.
So, if you have an IRA but maybe not enough to make the purchase you desire and you do not want to partner with others, perhaps to control the investment yourself you can actually partner with your own IRA, you now have another idea. Using this client’s example when a rent check comes in, 20% gets sent to her each month and 80% gets sent to her IRA. This allows her to individually make some monthly cash flow and meanwhile it puts 80% of the cash flow safely into her retirement account.
I must admit this was a very cool and creative way of making a great value play investment, while maintaining full control of the property and diversifying her cash flow in to both personal and retirement accounts.
Do you want to learn more about IRA investing? Contact us your real estate Sherpas for a complimentary strategy call!
We are not tax professionals or attorneys. Please always consult with an attorney and or licensed tax advisor before making decisions for your investments.