Investing

Why You May Want to Consider Using Your IRA to Purchase Property

Do you wish you could take advantage of the weak housing market, but don’t have enough cash on hand to put down to buy a property? Well, you might just be able to buy, rent and flip some properties using the funds from your Individual Retirement Account, or IRA. While that might sound crazy, it’s totally above board and seems to be gaining in popularity as more Americans choose to take direct control of their retirement investments.

Basic IRAs

IRA’s are a great way to save for your retirement, especially if your employer matches your contributions. But most IRA’s give people little control over their investment decisions. Most people get a slate of offerings from their IRA managers, usually limited to “high risk” or “low risk” equities.The common theme is that you must invest your money in either the stock or bond markets. Some might offer a commodity investment options, but many don’t.

The IRA market has been notably volatile since the 2008 financial crisis. Stock index levels have just recently returned to where they were before the financial markets bottomed in the fall of 2008 and spring of 2009. That means, on average, most of us haven’t seen much of a gain in value for three years.

Self-directed IRAs

You may fare well managing your IRA by yourself, meaning you choose what you invest in and for how long. This type of IRA is known as a self-directed IRA and it will allow someone to basically take their retirement funds and invest it in almost whatever they like. For many, that is a scary proposition, as one bad investment could see their entire nest egg wiped out. But for savvy investors, it could offer crucial capital at a time when bank lending is stringent.

Investing in Tangible Assets

One area that is of interest to value investors is tangible assets, like real-estate. Asset prices remain depressed and the banks are still reluctant to hand out mortgages to all but the best borrowers. This means a lot of Americans are renting. That’s where you come in. You can use the funds from your IRA to purchase and manage a property. The income stream you receive from your renters will flow back into your IRA, helping to build your nest egg.

Rules and Regulations

It sounds simple, but there are a lot of rules and regulations you need to follow in order to take advantage of this investment opportunity.

First, you need to find a property that is undervalued and in a neighborhood which attracts renters. Freddie Mac and Fannie Mae, the government-backed mortgage depots, may have an answer to that problem. They are currently running a pilot program to sell some of their foreclosed properties to investors who plan on renting them out. The great thing is that many of the properties already have renters, so it eliminates the need for you to find someone to fill the space.

Second, you must find a custodian to manage your IRA. The government doesn’t totally trust you to manage your own retirement account, so they have designated a few custodians to make sure you are doing everything to code. A custodian is similar to the broker dealer that currently manages your IRA (such as Fidelity). But there are only a few custodians that will allow you to invest in real estate. They include firms like IRA Resources, Equity Trust, Guidant Financial Corp, Entrust and a few others. But this service does not come cheap, so expect to pay several times the amount of fees to them that you  dish out to your current IRA manager.

It should also be noted that all of the money used to buy and maintain the property must come from your IRA. That means that you need a lot of money to first buy the property  – and then a lot left over to maintain it. You can get a loan on your IRA, but it will have to be a special non-recourse loan that has some limitations. As for the property itself, it must be a rental- you cannot live or vacation in it. You cannot buy the property from people the IRS considered a ”disqualified person,” i.e. a family member. And since an IRA is tax exempt, you won’t be able to claim depreciation on the asset.

Putting Your Capital to Work

That being said, there are a number of advantages to using your IRA. First, it is money that for some people is just sitting there passively. This will put that capital to work and get you truly involved in managing your retirement. All the capital gains and income tax is deferred, augmenting the firepower of your investment dollars. If you use a Roth IRA then your gains will be tax exempt.

The Bottom Line

There are dozens of other things for you to consider when pursuing a self-directed IRA. A good tax lawyer and accountant will be crucial to getting everything done right. Your custodian will also help you as they have had years of experience in this field. Being a landlord is a serious commitment and can be very time consuming, but the rewards could be worth the headache. For those that don’t want to actually deal with tenants and creaky foundations, it may make more sense to invest in a real estate investment trust or REIT, which pools real estate assets and pays out dividends to investors. But no matter how you do it, there may never be a better time for you to invest in real estate and your IRA could just be the tool necessary to make it happen.

Cyrus Sanati is a frelance financial journalist whose work has appeared in dozens of leading publications, including The New York Times, BreakingViews.com, and WSJ.com. Follow Cyrus on Twitter @csanati