Today’s REI Classroom Lesson
Clay Malcolm talks to us today about how real estate within IRA’s can be a great investment but also comes with additional responsibilities including insurance, tenants, repairs, and the need for property management.
REI Classroom Summary
Finalizing who should handle the property management will determine how finances have to be handled for rent, repairs, bills, etc. Clay Malcolm breaks it down for us so that your money and property are in trusted hands.
Listen to this REI Classroom Lesson
Real Estate Investing Classroom Show Transcripts:
Mike: Welcome back to the FlipNerd.com REI Classroom where experts from across the real estate investing industry teach you quick lessons to take your business to the next level. And now, let’s meet today’s expert host.
Clay: Hi and welcome to the REI Classroom. I’m Clay Malcolm at New Direction IRA and today we’re going to be talking about self-directed IRA ownership of real estate and the property management considerations that go into that.
Mike: This REI Classroom real estate lesson is sponsored by UglyOpportunities.com.
Clay: One of the things that you’ve probably encountered or thought about if you’re thinking about real estate and IRA is when your IRA buys a physical piece of property, it has the same property management considerations as an investor outside an IRA. It has to worry about taxes, insurance, finding tenants, collecting rents, all those things because the IRA, which is a legal and financial entity separate from you, actually owns that property. So it pays for the purchase and maintenance and insurance and all those expenses, but it also receives all the proceeds. It’s literally a . . . you can think of it as a different person. But you, as the IRA holder, you’re the one setting up how that property management occurs. There are a few ways that you can set it up. Some of them require a lot of your time and attention and some of them require much less. So that’s one of the factors that you might be thinking about in terms of which you choose.
Some have more fees associated with them than others as well. I would certainly encourage you to talk to whoever your provider is about their fees particularly for outgoing checks and things like that, the little things. Because a lot of providers have different fee schedules and so you may be able to find one that fits your needs better than somebody else’s.
So let’s talk about the actual structure. The IRS, of course, it’s giving you this money and a tax-deferred state to invest and so it’s going to track the money. And it does that largely through the custodians. And that’s why you’ll see this idea that the IRA’s finances basically live at the custodian. That’s kind of the financial hub.
So money gets disbursed from the IRA and the receipts, the rent and proceeds from a sale or whatever the financial machination is, that money comes back to the custodian. And that keeps it a little bit at arm’s length, which makes the IRS more comfortable about the fact that . . . there’s some thought that the IRS doesn’t trust us 100%. They’ve given us this money tax-deferred for a while, but they’re definitely going to keep an eye on it because they think that some of us might try to pay fewer taxes than they think we should. That notwithstanding, these are the mechanics you want to think about.
So you can, as a property manager, actually do that in a very direct way. So the IRA holder picks a vendor and says, “Hey, go put a new roof on the property,” or whatever it is. Goes to the IRA custodian, says “Hey, cut a check for that roofer,” and that’s the way that the transaction occurs. And each time the property has an expense, insurance, taxes, whatever it is, the IRA holder instructs the IRA company to make a payment. The rents come back to IRA custodial entity as well. And usually, they’re made out to the IRA. It has a different name than you personally because, again, it’s a legal entity. And so that’s the really direct route. That takes some attention. The IRA holder needs to be paying attention to what’s going on. The IRA custodian is not a property manager in and of themselves.
The next thing, however, is that you can hire a product manager. It has to be a non-disqualified entity and if you have questions about that, we’ll probably cover that on another REI classroom episode. But the non-disqualified property manager can actually perform a lot of functions. If you, the IRA holder, enter into a contract with them, you basically tell them what you want them to do. Now, they can handle your IRA money with a lot more ease because they’re non-disqualified. The IRS would like to kind of keep this money out of your hands, your personal hands, to keep that separation. The property managers can receive the rent, they can pay bills for your IRA-owned property, they can keep a cash reserve in case there are unexpected expenses, so on and so forth, similar to the way it would be outside an IRA.
The next thing, since we’re talking about non-disqualified persons, is that I have certainly seen IRA holders who don’t want to go to the custodian every time they want to check to a subcontractor, particularly if they’re doing a big rehab on a property. So what they’ll do is they’ll send a large amount to their general contractor or their CPA or a trusted friend or somebody like that who can then disburse those funds, collect the receipts and then they send all of the receipts and the unused money back to your IRA.
Now, one thing I’ll mention about that is you need to trust the person because once the IRA custodian disburses the money, we don’t have any control over it anymore. So you want to make sure that that person’s actually going to spend it on what you want them to spend it on. But it is a way to maybe ease up the mechanics that are involved in disbursing funds.
Then, the last setup I’ll mention is the corporate entity. And this one, there are several ways that that can occur. But an IRA can be a private equity or private stock owner in a corporate entity. That entity can be an LLC, C Corp, LP, can’t be an S Corp, that’s really the only one. But in that regard, because the corporate entity is also a legal entity, it can also be the hub financially. So it can receive funds for the IRA on property, it can disburse funds for, well, any bill, so on and so forth. So it can actually move the financial hub from the IRA custodian to the corporate entity.
You’ll probably hear a term called checkbook control IRA. That’s a version of a corporate entity being inserted into that process. It requires some risk tolerance on the part of the IRA holder, but it’s certainly something that a lot of people do.
So what you’re measuring, really, is your convenience, what your goals are, what your time commitments are going to be for the IRA. There are a lot of different factors. So once you know the rules and the way that you can set it up in these different ways, then you can choose the one that’s best for you. And if you have any questions, of course, come back to the REI classroom. We’ll probably be talking about it at some point. Thanks a lot for joining us today.
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