How You Can Get Started Buying Real Estate Using Your 401(k) or IRA

This article has been brought to you by The Madison Trust. Read our Editorial Guidelines for more information.

Did you know that you can buy real estate using your IRA or 401(k)? Most real estate entrepreneurs are unaware of how easy it is to buy real estate with their retirement money.

Welcome to the world of Real Estate IRAs.

1. What is a Real Estate IRA?

A real estate IRA is a supercharged IRA that enables you to invest your retirement money directly in real estate such as multi-family, commercial, land, fix-and-flips, tax liens, and more. It has the same tax advantages as a regular IRA and can be set up as a traditional, Roth or SEP real estate IRA.

A real estate IRA is also known as a self directed IRA.

2. How does it work?

Opening a Real Estate IRA can be done in three simple steps: Open, Fund and Invest!

Step 1: Open: You select a Self Directed IRA Custodian and open your account by completing their online application.

Step 2: Funds: You transfer or rollover all, or a portion, of an existing IRA, 401(k), or other retirement accounts, to fund your account By making an initial contribution.

Step 3: Invest: You instruct your self-directed IRA custodian to send your retirement funds for your real estate investments.

The process, from start to finish, usually takes 1-3 weeks.

You may want to consider upgrading to a checkbook IRA – which enables you to manage your IRA without the need to contact your self-directed IRA custodian for daily transactions – thus saving you time and money. There is savings.

3. Real Estate IRA Do’s and Don’ts

So, what can and can’t you do with the real estate in your IRA?

Since your IRA is intended to provide benefits for you in retirement, not today, there are some rules in place that ensure all benefits are protected for the future – when you are retired.

rule 1: You and members of your immediate family, such as your spouse, your parents and grandparents, children and grandchildren, and their spouses, as well as the entities they own – collectively referred to as Known as “disqualified persons,” you cannot benefit from your IRA today.

The most popular question we get is, “Can I live or vacation in a property owned by my IRA?” Unfortunately, you can’t until you retire and withdraw assets from your IRA. Hence, many people buy a property now, rent it out, then buy back the property on retirement and live in it.

Rule #2: The same group of “ineligible persons” cannot transact Together Your IRA.

The second most popular question we get is, “Can my IRA buy a property I currently own?” Unfortunately not. This is because if an unqualified person transacts with your IRA, this is considered “self-dealing” and is not allowed. All transactions with your IRA must take place at arm’s length with a non-related third party.

Another popular question we get is, “Who can work on the property and who can’t?”

The answer is that all work done on the property must be done by unrelated third parties.

The last question for now is “What if I work but don’t get paid for it?”

This would be considered “sweat equity,” a non-cash contribution to your IRA — and unfortunately, it’s not allowed. However, you may perform “desk work” such as hiring contractors and subs, paying bills, collecting rent, maintaining property, etc.

Rule #3: All income and expenses must flow directly into and out of your IRA. Always remember that you and your IRA are separate entities.

4. Non-Dependent Funding for Your IRA

There is always more real estate to buy than cash on hand. This is why most savvy real estate investors use leverage to grow their portfolios.

When using leverage in an IRA, there are a few things you need to know.

First, you can’t borrow money from “disqualified people” (the immediate family members listed above) – you can only borrow from unrelated third parties.

Second, you cannot personally guarantee the loan. It must be a non-recourse loan.

Third, when an IRA borrows money, the net income attributable to the loan is known as UDFI, Undistributed Debt Funded Income, and is subject to tax. Although no one likes paying taxes—especially on an IRA—it’s almost always worthwhile when you do the math, because at the end of the day, you’ll have more money left than if you didn’t take out the loan. Is. Your self-directed IRA custodian can walk you through the math, if you’d like.

5. Upgrading to a Checkbook IRA

You may want to consider upgrading your Self Directed IRA to a Self Directed IRA with Checkbook Control. This will enable you to manage your IRA without the need to contact your Self Directed IRA Custodian for daily transactions – thus saving you time and money.

Checkbook control is best suited for investments like real estate that have a lot of transactions — or if you’re making multiple investments in your IRA.

Upgrading to Checkbook Control only adds one extra step to the process!

How does this work? It’s usually a simple four-step process- open, fund, build and invest!

Step 1: Open: You open your account as described above.

Step 2: Funds: You add money to your account as described above.

Step 3: Build: Your self-directed IRA custodian sets up a new LLC—or trust—for your IRA that will serve as the self-directed investment platform for your IRA. You are appointed as its manager or trustee, who is authorized to take all investment decisions. Upon your instruction, your self-directed IRA custodian will fund your IRA LLC or trust at a bank of your choosing.

Step 4: Invest: You can start investing by simply writing a check or sending a wire.

The process, from start to finish, usually takes 2-3 weeks.

6. Airbnb and Vrbo in Your IRA

“Can my IRA invest in Airbnb or Vrbo?”

Yes it can, but why is it even a question here. As a relatively new asset class, it is not referenced in the Internal Revenue Code. It falls somewhere between a typical rental property and a hotel.

A typical rental property is considered a “passive” investment and is non-taxable. A hotel, on the other hand, is considered an “active” investment — and if held in an IRA, it will trigger a tax known as UBIT, Unrelated Business Income Tax.

So, the question is, what is considered Airbnb or Vrbo? And is it subject to UBIT?

The IRS has not issued clear guidance on this. So, what do you do?

Here’s the general guidance we’ve got—as long as you don’t provide daily maid service, breakfast, or other personalized services a hotel might provide No Considered “active” and UBIT will not apply. If Airbnb or Vrbo is part of your strategy, you should consult with your tax advisor.

7. Fix-and-Flips in Your IRA

When buying a property in an IRA to fix-and-flip, there are two main considerations you should be aware of:

1. UBIT, the unrelated business income tax, and
2. Who can and can’t do actual renewal

When you buy a property in an IRA and rent it out – it’s considered a “passive” investment, and the income is non-taxable. When you recover and repatriate property in an IRA — it may be considered an “active” investment — and may be subject to UBIT, the unrelated business income tax. The IRS has not issued clear guidance on this. So, what do you do? The general guidance we’ve received is that if you flip two or more properties within a short period of time, less than 12 months, you may be subject to UBIT. In a shorter, or longer time frame than this, you probably are not. If fixing and flipping is part of your strategy, you should consult with your tax advisor.

The second consideration is “Who can work on the property and who can’t?”

The answer is that all work done on the property must be done by unrelated third parties.

“What if I work but don’t get paid for it?”

Once again, this would be considered “sweat equity,” which would be a non-cash contribution to your IRA — and unfortunately, it’s not allowed.

8. Land in Your IRA

Land is a very popular self-directed IRA investment option. IRA investors typically buy and hold land because, historically, it has appreciated over time, which is ideal for the long-term investment horizon of an IRA. The main thing you need to know about buying land in your IRA is that all expenses — such as real estate taxes — must be paid by your IRA, not by you personally.

Additionally, you can’t pay the expenses personally and then get reimbursed from your IRA. Your IRA must pay them directly—or through a third party, such as a management company.

9. Tax Lien on Your IRA

Bidding on tax liens is a time-sensitive investment that requires funds to be immediately available at the time you bid. This is where the power of a self-directed IRA with checkbook control comes into play. Whether in person or online, you always have instant access to your IRA funds, allowing you to purchase tax liens without having to go through your IRA custodian.

10. How do I choose the right Self Directed IRA Custodian?

There are three factors to consider when choosing a self-directed IRA custodian—customer service, reviews, and fees.

You want to choose a reliable company that has a knowledgeable and friendly staff based in the US that answers the phone without making you wait. They should have thousands of 5-star reviews across multiple online platforms such as Google, Yelp, BBB, and Facebook.

Self-directed IRA custodians structure their fees as either flat-rate or asset-based. Flat-rate is when the fee is fixed regardless of the value of your account. Asset-based is when the fees are based on the value of your account. The larger your account, the larger the fees. You want to choose a trust company that offers a flat-fee structure, so you pay less in fees.

Note by BiggerPockets: These are the views expressed by the author and do not necessarily represent the views of BigPockets.