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By Bill humphrey,
President, New Direction IRA
Know Thy Self-Directed IRAs
help your clients invest via this unique approach to funding
The Ira may invest in all types of real
estate: residential, commercial, land,
etc. all income and expenses must go directly to and from the Ira. Mortgage professionals also should know that an Ira
can lend money to a real estate investment group, buy stock or equity in such
a group, or begin a limited liability company to manage real estate. No matter
the structure, disqualified persons and
prohibited transactions rules still apply.
There’s another detail that mortgage professionals and their clients must be clear
about: an Ira can only borrow money
from non-disqualified individuals and
entities on a nonrecourse basis. This
means that an Ira may take out a mortgage to help pay for a real estate property, but it must be a nonrecourse loan
because of IrS rules. There are fewer
lending institutions and banks that offer
these types of loans, but some do exist.
Banks or private lenders offering nonrecourse loans will often require Ira
holders to put 30 percent to 40 percent
or more down, since the loan is only
secured by the Ira’s assets. The loan
seeker also may have to prove that the
property will appreciate in value or generate some sort of positive cash flow.
Only assets held within the Ira can
serve as collateral for the loan. In other
words, an individual cannot pledge anything outside the Ira as collateral nor
sign a personal guarantee of any kind.
Similarly, if the Ira partners with another Ira, individual or entity, the Ira
holder must have a non-disqualified
person guarantee the loan.
Taxes and income
The IrS gives tax-deferred status on all
income generated by Ira funds. It does
not, however, shelter the profits of the
income generated by funds brought
into an account in the form of a loan.
Unrelated business income tax (UBIT)
was created as a way to even the playing field between tax-free nonprofits
and corporate entities. It’s applied to
Iras and other retirement plans that act
similar to nonprofits. Unrelated debt-financed income (UDFI) is essentially
another term for UBIT in this instance.
Because the IrS doesn’t allow unlimited ability to contribute to a tax-advantaged account, only the Ira
contributions and earning are not subject
to UBIT. The amount of money individuals can put into their Ira is capped by the
annual contribution limits, so by taking
out a mortgage, investors can increase
the purchasing power of their Iras.
UBIT is assessed only on the debt-financed portion of the investment. For
example, if an Ira buys a home using a
Agrowing number of investors are turning to self-directed in- dividual retirement accounts
(Iras) in the face of market volatility, choosing to invest their retirement
funds in alternative assets like real
estate, private equity and more. recent estimates have shown that self-directed Iras now represent between
2 percent and 5 percent of the $4.6 trillion Ira market.
Self-directed Iras offer individual investors true diversification and the ability to manage their retirement funds in a
way that gives them the control and freedom to adapt to economic conditions.
It’s not difficult to make these investments with an Ira, but many investors
still don’t know that they can use their
Iras to buy real estate or that they can
use leverage to purchase those assets.
That’s where savvy mortgage professionals can come into the picture.
although many of your clients undoubtedly have Iras, it’s very likely that some
of them don’t realize those Iras can be
used to borrow money and purchase real
estate assets for their accounts.
as mortgage professionals know, real
estate can provide an excellent investment opportunity, and a self-directed
Ira is another source of funds that can
take advantage of that. When other
lending products are slowed by market
conditions, offering to leverage self-directed Ira assets can be an intriguing
option to offer your clients. These Ira
holders have the opportunity to make
money for their Iras with funds outside
of what they can contribute, and lenders
are the key to this opportunity.
With all of this in mind, mortgage
professionals should familiarize them-
selves with the intricacies of self-
directed Iras and the way in which
they can be used to buy real estate.
here’s a primer for the uninitiated.
mortgage, UBIT will be assessed on the
leveraged portion, not the portion that
the Ira contributed. In this way, as a per-
son’s Ira pays off a mortgage, the per-
centage that incurs UBIT will decrease.
UBIT rates for almost all retirement
accounts follow a schedule of trust
rates provided by the IrS on an annual
basis. Note, however, that the percent-
age of profits that are attributed to the
outstanding loan percentage at the
sale of leveraged real estate is taxed
at the long-term capital gains rate.
Mortgage professionals and their clients
should know that there are several rules
by which an Ira holder must abide in
order to invest in real estate. Generally,
the Ira may not deal with “
disqualified persons” to the plan. Those who
are considered disqualified to a given
Ira are the Ira holder, that person’s
spouse, parents and grandparents, children and grandchildren, those people’s
spouses, and certain fiduciaries and entities owned by any of these people. The
IrS considers “prohibited transactions”
to be any interaction between the Ira
property and a disqualified person. This
means that a disqualified person cannot
live in the property, provide direct funding to it, fix it personally or pay for it to
be fixed, and more.
a high-quality self-directed Ira provider can be an ally in assisting mortgage bankers, their colleagues and
their clients in real estate Ira investments. a self-directed Ira provider can
help clarify rules, serve clients, build
trust and more. Leverage always provides opportunity, and a self-directed
Ira provider can show you how to take
advantage of that in an Ira.
• • •
a real estate investment with a self-
directed Ira can be a valuable tool for
any investor. as investors grow weary
of the stock market and fluctuating pre-
cious metals prices, there may be a
growing need for businesses to help in-
terested parties acquire real estate prop-
erties. Well-informed mortgage profes-
sionals can do just that, and stay ahead
of their competition in the process. •
Bill humphrey and Catherine Wynne founded
New Direction Ira (NDIra), a self-directed Ira
provider, in 2003. humphrey is an expert in self-
directed individual retirement accounts (Iras),
health savings accounts (hSas) and other
tax-advantaged accounts, as well as related
IrS codes. Wynne is recognized nationally as
an expert in the IrS rules for Ira investment in
alternative assets. Both teach classes nationally
on taxes, retirement accounts, alternative assets
and more. E-mail firstname.lastname@example.org or
Wynne at c email@example.com.
For starters, mortgage professionals
should know that “self-directed” is a
descriptive term, not a legal or IrS dis-
tinction. It indicates that the account
holder will have some choices as far as
which assets are purchased by the Ira.
That could mean a choice between two
stocks or a choice between all the as-
sets the IrS allows, such as real estate,
precious metals and other alternative
assets. Similarly, you may have heard
descriptive terms like “real estate Ira”
to refer to a self-directed Ira that holds
real estate assets. This is a marketing
term, however, not an IrS distinction.
Many Ira providers exclude assets
like real estate from the investment op-
tions they offer clients. The Ira provider,
not the IrS, determines what invest-
ment types are offered. Therefore, in-
vestors need to find a self-directed Ira
provider to service any investment that
they want to pursue in real estate.
Further, mortgage professionals
should know that the type of plan — i.e.,
traditional, roth, 401(k), etc. — does
not dictate what type of investment
is allowed. Each account, whether it’s
self-directed or not, has the same tax
advantages and the same contribution
and distribution rules as any other com-
mon Ira. The difference is the assets in
the account, not the account type. For
instance, an investor may take a tradi-
tional Ira, open an account with a self-
directed Ira provider and then begin
investing that Ira in real estate.
This is only a cursory look at how to in-
vest an Ira in real estate and some rules
regarding how to manage the property
or properties. More information about
self-directed Iras can be found online,
and interested mortgage professionals
should certainly pursue further edu-
cation in this matter.
That noted, let’s take
a closer look at the ac-
tual real estate invest-
ment process as
it relates to self-
after finding a self-
directed Ira provider,
the Ira holder will locate a
property to purchase and agree
on the terms of the deal with the
seller. The Ira holder will notify the
self-directed Ira provider of the closing
date and, at closing, the provider will
send funds from the Ira and the lender
will send the remainder. Note that every-
thing must be done in the name of the
Ira. If this is not done properly and Ira
funds are used, the Ira will be distrib-
uted with penalties and taxes assessed.