Diversifying Into Real Estate Via Self-Directed IRAs

When someone approaches me about buying a property I rarely ask about their financing. I assume they have done their due diligence and they know their budget. I look at my job as guiding buyers into the best situation for them individually: the right neighborhood, with their “must haves,” for the best price. I am their knowledge base and am careful to dispense that knowledge with honesty – and just a little humor.

Dream Of Living On The Beach

This photo was taken by Trent Bayliss, on the beach, directly in-front of Royal Palm.
This photo was taken by Trent Bayliss, directly in-front of Royal Palm.

Some people dream of living right on the beach, so I know immediately the stunning Royal Palm development in Nueva Gorgona might just be the place, or if they have the budget, the ultra luxurious Casa Bonita might be more suitable, and it is located just ten minutes from Panama City. If they are looking at a more residential and upscale property, I might suggest Punta Vela in Coronado.

I focus on giving unembellished facts so they can make the best decision. It’s their responsibility to pay for their dream.

I am fortunate to have several options I can offer buyers, such as attractive builder financing and long term tax abatements, but many times these are just part of the equation.

The IRA Is The Purchaser

The other day I was filling out the paperwork on a property in Coronado Golf, and the purchaser said: “I’m not buying the property, my IRA (Individual Retirement Account) is making the purchase.”

“So you are going to be renting the property?” I questioned, pausing with my pen in mid-air.

“This is purely an investment. I’ll be renting it and will never be there myself,” the woman in her early 40s replied. “The custodian for the IRA will be in touch as to where to send the paperwork,” she continued.

An Interesting Option

It wasn’t the first time I had sold a property to an IRA. I am not a financial person, and I certainly would never suggest that I could give advice about how an IRA might make such a purchase. However, what I do know is that purchasing through an IRA is pretty straight-forward, and the option is very appealing, given the current financial landscape.

The New York Times article outlined how a 47-year-old man from Virginia took $80,000 from his IRA to purchase a three-bedroom home on the beach. He invested another $23,000 for a remodel and then had the property evaluated. The property was appraised at $147,000 for a nice $44,000 profit. However, the gentleman was happier with the $13,200 annual rental income.

No Scamming The IRS

Play by the rules. If you don't like the rules, MOVE!
Play by the rules. If you don’t like the rules, MOVE!

There are a lot of rules about using IRA money to purchase property. It is reported that the Internal Revenue Service (IRS) can hit anyone who tries to scam the system.

Again, I’m no expert, but I know you must have your IRA as a “Self-Directed IRA” which means it is held by a custodian and managed by the account holder. As the owner of the IRA, the individual or their family members, can’t use the real estate the IRA has purchased. The property must be strictly an investment. It absolutely cannot be a second home or a personal residence, which explains how I knew my new buyer wasn’t interested in living in her most recent purchase.

Once a property is purchased, all the money relating to the property stays in the IRA. For example, you can’t take realized equity or any of the rental income without paying taxes – just as you would if you withdrew money, which had been invested in the stock market, from the IRA.

Straight To The Bottom Line

Any profit such as rental money must go directly into the IRA. While you are limited on how much fresh money you can add to your IRA annually, you are not limited to the amount of “profit” on the existing money you can add each year. Consequently the $13,200 in annual rental income went directly to the bottom line of the Virginian’s account. As someone in their 40s he is limited, by law, to adding only $5,500 new money each year so another $13,200 will add up quickly in a tax-free instrument. I’d be excited too!

If you want to take money out of an IRA, you would have to pay taxes just as you would with any monetary distribution. All taxes or repairs to the property must be made with IRA funds. You cannot co-mingle your IRA money with your non-retirement money.

According to Forbes, a US based financial publication, there is little incentive for banks and other large financial organizations to do much more with IRAs than to invest the money in stocks and bonds. There are a handful of smaller companies who manage these Self-Directed IRAs. I believe these companies currently charge, on average, about $400 a year to act as the IRA’s custodian.

Diversifying Retirement Funds

By all accounts, taking your IRA money and investing it in property is a great way to diversify retirement funds and, if managed well, produce higher returns than other, more traditional vehicles.

I was surprised when I read that the US businessman and politician, Mitt Romney, had as much as $25 million of his IRA invested in property on the Cayman Islands. Of course I had to ask myself how someone could possibly have $25 million in an IRA, but as I read further, I learned that you could take a 401k and roll it into an IRA. Additionally, self-employed individuals may invest more than the current individual limit of $5,500 if they are younger than 50-years-old or $6,500 if they are fifty or over.

Mitt, Warren, and The Donald

Mitt’s not the only person capitalizing on the Self-Directed IRA real estate bandwagon. Both Warren Buffet and Donald Trump are quoted in national publications as endorsing the practice in certain situations. I had to wonder how much they might have in their IRAs – but knew there would be too many zeros for me to focus.

I’m Your Property Expert…

Even if you, photo bomb my pictures!
…Even if you photo bomb me!

Nothing is without risk. Many individuals investing in real estate before the US economic downturn, lost billions, just like those who invested in the US stock market in the early 2000s. It’s vital that you research where to make your real estate purchase.

Fortunately for those of us in Panama, the value of real estate has gone up steadily and with the current limited inventory on the beaches in Panama, the long-term looks very promising. Whether or not you use IRA funds to fund your investment is certainly not my business, but if you want the untainted truth about the properties, I’m your expert.

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