Today’s REI Classroom Lesson
Today, Clay Malcolm breaks down 5 types of real estate investments you can do within your IRA, including how each works.
REI Classroom Summary
Clay Malcolm, an expert in all things related to IRAs, explains how to use your IRA for alternative assets, specifically for real estate.
Listen to this REI Classroom Lesson
Real Estate Investing Classroom Show Transcripts:
Announcer: 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: Hello and welcome to the REI classroom. My name is Clay Malcolm at New Direction IRA, and today we’re going to be talking about five types of real estate IRA investing.
Announcer: This REI classroom real estate lesson is sponsored by TheInvestorMachine.com, FlipNerd’s private investor coaching program and your blueprint to investing success.
Clay: It’s really common for somebody to call me at the office here at New Direction and say, “Hey Clay, I heard that my IRA can be a real estate investor. I want to do that.” And so, it’s interesting because real estate is such a broad asset class that that’s really just the beginning of the conversation. So I wanted to dial it back to basics just for a moment so that anybody who’s out there who’s considering real estate in their IRA can figure out or at least conceptualize how they want to be a participant.
At its very core, the IRA is going to own one of three things. It’s either going to own a physical thing, like a house, an apartment building, or a warehouse; it’s going to own a note, so some sort of promissory note, whether they originated it or they bought it from somebody else; or they’re going to own some type of equity, so you’re a participant in a LLC, a limited partnership, or even a C-corp that’s out there investing in real estate. Those are the three core ownership types of assets that an IRA can own.
Now, of course, you have to have your IRA at a provider who handles all of them, but the actual asset itself is going to be one of those three things.
So let’s talk about some of the real estate variations of those, and we’ll start with the easiest one. So, if your IRA wants to be the title holder of a piece of property, and in that tax advantage state receive rents and hopefully proceeds from sale and all the kind of thing, it absolutely can be. So it can be the 100% title holder of a piece of property and all of the revenues that are generated by that property come back to your IRA in a tax advantage state.
Now, of course, your IRA also has a pay for purchase and maintenance and all that kind of stuff, but that’s the way it makes money. So, that’s easily the one that is the most simple to conceptualize.
Second one is not a very long leap from there. So, if your IRA wants to be the titleholder, but doesn’t have the full purchase price, and it wants to buy an asset using debt leverage, it can. Does typically have to be a non-recourse loan because the IRA holder can’t pledge their personal assets in service of the loan that their IRA is taking out.
And that generally changes the terms of the loan a little bit, but non-recourse loans IRAs are becoming more and more common, and lots of people are using it. We would say here at New Direction, we probably have 40% of our real estate owners that are using debt leverage, and I’m one of them.
So that’s another ownership structure for your IRA, and the only difference in terms of the money flow is, of course, the IRA, when it receives rent, is on the hook for the debt service until such time as they pay off the loan.
Next ownership is also title ownership, but with partners. So you can be tenants in common . . . your IRA can be tenants in common with other owners, and it could be as many as you want. The other owners could be other IRAs, other people, other companies, a trust. Any of those structures can be side-by-side owners with your IRA.
So we certainly see people who want to have a piece of an asset, but they don’t have the full purchase price or they have other people that they want to be part of that asset and the returns that are generated by it, and so they’ll just be tenants in common. And all of that is on the title work as well, so that’s another relatively direct ownership means.
Now, the last two are the other two ownership structures that I talked about before. So, if your IRA wants to be in real estate, but really what you want it to do is be a lender, then that’s obviously possible. Your IRA can be a lender. Those notes can be, if you’re originating them, either secured by collateral or not, so it could be bridge loans, construction loans, even mortgage type loans.
So your IRA can be a lender. It has to follow all the lending rules in a particular state, but other than that, the IRS doesn’t really get into restricting that very much. So, your IRA makes the loan and the borrower pays it back to your IRA. All of it comes back in tax advantaged.
And again, these can notes that your IRA originates, or we do also have lots of IRA holders who are buying non-performing notes, renegotiating them and that kind of thing, auto paper, all kinds of things. So, in terms of the promissory note arena, that can still be real estate investing but just in a different ownership form.
And then the last one I’ll talk about, of course, is partnering via an entity. So an IRA can be an investor in an LLC or an LP or C-corp, not an S-corp. And can’t be a general partner, but can be a limited partner in a partnership.
So, those entities might be collecting investors to go out and, say, buy an office building or something that none of them individually could afford. So, that’s another way for your IRA to be able to participate and have an ownership structure that allows you to not necessarily have the full purchase price. So you do have a lot of ways to figure out in terms of how you want the ownership structure to be.
Now, the reason that might be important is IRA investors have a little bit of a very overt plan that is usually associated with your distribution strategy. So 59.5, the early withdrawal penalty goes away, 70.5 . . . if you’re in a pretax account, then at 70.5, you’ll probably have to start taking required minimum distributions, and so you have some timeframes that you’re looking at.
So, depending upon what age you are, that might have something to do with which ownership structure that you pick, because that also dictates how the money is returned to your IRA and when. So the timetable is often important.
Some of these investment types incur something called unrelated business income tax. So if you use debt leverage or if you’re in certain types of entities, you might have some UBIT. If you don’t want to mess with UBIT, then you might choose a different ownership structure. So that’s another decision that you might think about.
And then always, the decision about distributions. So anything that’s in your IRA can either distribute in kind, which is the actual thing, so you can actually distribute a house or apartment building to yourself, or your IRA can liquidate at first and you can take distribution of cash.
And like I said, because IRAs are set up the way they are with certain rules about distributions, I do think that the time element of it is a little bit more upfront for those investors.
So I encourage everybody to think about their IRA and the particular rules that are associated with it as a tool, and make sure that you think about the rules of the tool or the way that it operates so that you pick the asset that is the best thing for you and for your overall retirement, because of course, IRAs are just part of your overall financial picture.
So, if you have questions about this, NewDirectionIRA.com has plenty of information. I hope that you will take the time to do a little bit of research. You do have some great options on your plate, especially when it comes to real estate and the real estate as an asset class is wide open to you. Hope this is helpful for you on the REI classroom, and we’ll see you next time.
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