IRA Real Estate Investments

Note: Most of the information in this section comes from Polycomp who provides custodial services for IRAs. If you Google "self directed IRA custodial services" you will find that there are several companies who provide similar services. I only chose Polycomp so I would have representative costs and procedures.

Below I listed the major points about holding investment real estate in your IRA.

  • There are very few restrictions as to the type of real estate as long as it is an investment property.
  • Properties purchased through your IRA can be financed. The loan must be a "non-recourse loan". This means that you are not personally liable for the debt. The lender's only recourse is the property. North American Savings Bank is one such lender and has an informative FAQ
  • You can use 1031 Exchanges with properties held in the IRA.
  • All actions must be at arms length. This means:
    • You must use a property manager; you can not manage the property yourself.
    • You may not personally do work on the property; a third party has to do it and the invoices are paid by the custodian or the property manager. Note: We work with third parties to rehab properties all the time. The property manager and I have recommendations for all the services and the property manager and I supervise the work that is performed.
    • You may not mix personal and IRA funds or the entire transaction may become an "early withdrawal" from your IRA and taxed as such.
  • You do not hold title directly; the custodian holds direct title for you. For example, if you were using Polycomp the deed would show something like: "Polycomp Trust Company, Custodian FBO {your name} IRA".
  • You can put properties in a LLC within in your IRA for protection.
  • You must report the market value to the custodian each year. This will require a brokers price opinion (BPO) which we will provide to your IRA custodian each year in accordance with IRS requirements.
  • The custodian will be the actual entity signing the closing documents.
  • When we make an offer, the offer name will be "{your name} IRA or Consignee".

Polycomp Costs

I am not recommending Polycomp but I believe their fees are representative of similar companies. Here is a fee schedule for Polycomp. Below are the costs that I believe apply when purchasing real property.

Note that the $95 IRA setup fee is a one time fee and would not be charged again as long as additional properties are held within the same IRA account.

Non-Recourse Loans

I am not recommending North American Savings Bank (NASB) but I believe their fees are representative of similar companies. A lot of the information in this section comes from North American Savings Bank's website. NASB provides non-recourse loans for investment real estate held within an IRA. See the North American Savings Bank FAQ page for more information.

  • If there is a default with a non-recourse loan the lender can only act on the individual property they financed. So, worst case is that they take back the property. The downside is that the cost of a non-recourse loan is higher than a conventional loan. For example, the rate today for a 30 year fixed rate 20% down loan is 4.625%. A 20 year 40% down fixed rate non-recourse loan is 6.25%.
  • NASB offers the following fixed loan types:

  • It appears that the key metric for a property qualifying for a non-recourse loan is the ration between NOI and annual debt service called the Debt Service Coverage Ratio (DSCR). This is the minimum ratio which must be met for a property to qualify for a loan. For example:

Since the DSCR is 1.56 (DSCR = (1200 x 12)/(767 x 12)) which is greater than the minimum required ration of 1.25 for single family homes this property would qualify.

  • The fees for NASB non-recourse loans are listed below. These are not that different from a typical conventional loan.

1031 Exchange vs. IRA

When I started reading about the advantages of holding property within an IRA I saw some parallels with a 1031 Exchange so I put together the following comparison. Note: the information in this section comes primary from: Patrick Rice - IRA Wealth, Second Edition: Revolutionary IRA Strategies for Real Estate Investment. Square One Publishers.

Is the tax on the gain deferred?

  • 1031 Exchange - Internal Revenue Code 1031 allows individuals to exchange one property for another deferring taxes on the gain. So, as long as you follow 1031 rules (we work with a Qualified Intermediary to facilitate the 1031 exchange and have never had a problem), the tax on the gain is deferred until you sell your last property. And, I have been told that you can get most of your money out without ever selling the property.
  • IRA Investments - The tax on the gain in traditional IRAs is deferred until start withdrawing from the account. If your property is mortgaged you may have be subject to the Unrelated Business Income Tax. See below for information on Unrelated Business Income Tax (UBIT).

What is the effect of a sale?

  • 1031 Exchange - You either buy another property that conforms to 1031 rules and procedures or you pay tax on the gain.
  • IRA Investments - The taxable gain is either deferred or exempt, depending on the type of IRA you have. You do not have to replace the property. Note that the leveraged portion of the gains may be subject to the UBIT.

Potential Taxes On Leveraged Profits

There is a tax on the leveraged portion of the profit called the Unrelated Business Income Tax or UBIT. Here is the IRS page on UBIT. Here is the actual tax form. The basic calculation is:

((profit - expenses) x (% leveraged) - $1000) x UBIT tax rate.

Here is where I found the following UBIT tax table

Remember that since you only pay taxes on net income so I doubt you will pay much (if any) taxes the first few years of ownership due to depreciation and other expenses.

Below is an example calculation of the UBIT for year one of a purchase:

So, no tax would be owed in this example and the -4,055 would offset other UBIT taxable income in the IRA or be carried forward to offset future UBIT taxable gains. Suppose that instead of a loss you had a $2,000 after deductions gain. The UBIT tax would be:

($2,000 - $1,000) x 60% x 15% or $90

Potential Taxes Due On Sale

Suppose you decided to sell a property that was 60% leveraged and after deducting the cost of sales and other expenses you had a UBIT taxable gain of $20,000. The tax on the gain would be:

((($20,000 - $1,000) x 60%) - $11,200) X 35% + $2,895 or $2,965

Note that if the loan is paid off 12 months prior to the sale, there is on tax since you only pay tax on the leveraged portion of the gain. Also, if you have paid down the loan to the point where you will have to start paying a meaningful amount of UBIT tax, it may be time to consider a 1031 Exchange.

When Does Real Estate in You IRA Make Sense?

During times of economic uncertainty, inflation or as you approach retirement and wish to reduce the stock portion of your IRA and increase the fixed income portion.

Our Service

The real estate you put into your IRA has to perform so it is critical that you get performing properties. We provide a one stop service for investors:

  • Selecting performing properties using our software and market knowledge
  • Working with your lender and custodian to submit offers
  • Coordinating with title, your lender and your custodian to get documents executed and the property closed
  • We coordinate with the property manager and and third parties to perform any rehab necessary to get the property ready to rent
  • Prepare marketing material for your property
  • Annually, prepare market valuation reports and submit them to your custodian as required by the IRS

Note that we work with investors world wide; very few of our clients live in the Las Vegas area. Click here to see a visual summary of the services we provide our clients.

Thanks for your time.

Eric Fernwood (Realtor)
VIP Realty (Vegas International Properties)
7570 Norman Rockwell Ln., Suite 140
Las Vegas, NV 89143

© 2014 Eric Fernwood, All rights reserved., 702-358-8884

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