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Buy into the Real Estate Market Using Your IRA or 401 (k)

by Timothy Taylor, Estate Planning Schools

Are stock market woes preventing you from building wealth in your retirement account? Do you feel that the current downturn in the real estate market presents a good buying opportunity? Have you wondered how to diversify your retirement accounts with real estate investments? Yes, you can buy real estate or an investment property using your IRA. If this is something you're looking to do, you'll want to read on.

Many traditional retirement accounts offer investment options in real estate by way of mutual funds, REITS, TICs and other managed portfolios. However, if you have been paying attention to our economy and the recent subprime mortgage debacle you are aware of the current ills of the housing market and historically high foreclosures.

While our elected officials and the banking industry consider various ways to stop the bleeding the reality is that housing prices nationwide continue to drop and foreclosures continue to rise. The question is how long can this go on? The media would like us to believe that we are in a recession that could last a few years. Many experts however believe that the bottom will hit this year and then turn around after the election.

Regardless of who is right, one thing is for sure -- this correction in the real estate market is presenting some very good buying opportunities for the astute investor. However, there is one problem -- the credit markets have tightened up considerably and finding easy capital to fund these real estate buying opportunities is harder.

Not to worry. You need to look no further than your own investment money sitting in your IRA or 401 (k) account.

In other words, Congress has already provided a way to help the real estate market. IRS rules actually allow certain self-directed IRA's and 401 (k)'s to directly purchase real estate for investment purposes.

That's right; you may be able to roll your current IRA or 401 (k) money into certain self-directed accounts that allow you to have checkbook control of your retirement money.

You can invest in Flip's, Foreclosures, Rentals, and do joint ventures. And, your investment possibilities are not limited to real estate. You can invest in just about anything except life insurance and collectables. In fact, one of our students at Estate Planning Schools purchased cemetery plots at deep discounts and plans to re-sell them later... with her 401 (k) money.

If this option of using tax-deferred funds (Roth money works too) to purchase property sounds appealing, you'll need to work with a professional or custodian that can show you how.

At the Estate Planning Schools of America, we offer investors a course on self-directed retirement accounts that explains how to do this legally for only $75.

We also offer to our students who buy the course a full service of setting these unique self-directed accounts up. The cost of setting up a self-directed IRA or 401 (k) with EPSA is $3,500 which includes all set up fees and one year of follow-up support.

Here's How it Works

Most banks and brokerage companies–the most common IRA account options–limit your choices to certificates of deposit, stocks, mutual funds, annuities, and similar financial instruments. But Section 408 of the Internal Revenue Code permits individuals to purchase land, commercial property, condominiums, residential property, trust deeds, or real estate contracts with funds held in many common forms of IRAs, including a traditional IRA, a Roth IRA, and certain 401 (k) accounts.

The IRA account holder can't serve as the custodian of his or her own account. However, there are select custodians that will facilitate IRA's and 401 (k)'s that can own LLC's where all the investments should be made. The owner of the account acts also as manager of the IRA-LLC and therefore gains checkbook control over his retirement funds to make investments as he/she deems beneficial.

There are several rules and limitations that must be followed before the investments are made to keep the account from possible default. It is imperative that the owner/manager become knowledgeable of all the rules and work with experienced professionals in setting up these self-directed accounts.

Fees can vary widely among custodians, as can the flexibility of the services provided for account holders. There are some custodians that do not utilize an IRA owned LLC and will hold the real estate on your behalf, but does not service it (collect the rent, etc.), you may have to contract with other providers. However, you must be sure that all rents are paid into the IRA and that all taxes are paid by the IRA.

Since buying a property may require more funds than you currently have available in your IRA, you also can have your IRA purchase an interest in the property in conjunction with other individuals, such as a business associate, or friend. Also, if the property is leveraged, the debt must be a non-recourse promissory note.

It is important to know that the Internal Revenue Service regulations will not let you use the real estate owned by your IRA as your residence or vacation home. Nor can your business lease space in your IRA-held property. The underlying premise for any real estate investment purchased with IRA funds is that you can't have any personal use or benefit of the property. To do so may cost you plenty in taxes and penalties.

There are a few other IRS limitations as well. You cannot place a real estate property that you already own into your IRA. Your spouse, your parents, or your children also couldn't have owned the property before it was purchased by your IRA. (Property owned by siblings may be allowed.)

Operating an IRA-LLC held Property

Because all property expenses, including taxes, insurance, and repairs, must be paid from funds in your IRA-LLC, you'll need liquid funds available in your account. Of course, all income generated from the property will be deposited in your IRA-LLC account so you can use that money to cover your costs. You also can make annual contributions within federal guidelines to your IRA and then move the money to the IRA-LLC for use.

Currently, you can contribute $4,000 in 2007 to a traditional or Roth IRA ($5,000 if you're age 50 or older). In 2008 the amount increases to $5,000 with $1,000 more if you are at least age 50. If you're a self-employed individual with a 401 (k), you can sock away as much as 20 percent of your annual compensation up to $45,000, ($50,000 if older than 50).

It's also possible to sell properties while they are held by your IRA, so long as the purchaser is not a child or parent. Once a deal closes, your IRA account now holds the cash proceeds–ready for you to make your next investment. An alternative is to sell an IRA-held property with seller financing so that all payments made by the buyers are paid to the IRA.

Distributing or Selling Your Property

You can withdraw real estate from your IRA and use it as a residence or second home when you reach retirement age (age 59 1/2 or older for a penalty-free withdrawal). At that time, you can elect take an in-kind distribution of the property. Under that arrangement, your IRA assigns the title to the property to you personally. You will then have to pay income taxes on the current value of the property, unless the property was held in a Roth IRA, then you won't owe taxes at distribution. This makes a Roth IRA extremely attractive if you anticipate that your real estate investments will appreciate over time.

You may also sell the property at retirement and withdraw the cash. You may not, however, sell the property in the IRA to yourself or any other disqualified person.

Prohibited Transactions

One of the most important advantages of taking our course on self-directed accounts is in understanding prohibited transactions. The Internal Revenue Code (section 4975) specifies what transactions may be legal to make by your IRA without being deemed distributed. IRC 4975(c) (1), identifies prohibited transactions to include any direct or indirect transaction between the plan and a disqualified person.

Take charge of your retirement dollars and capitalize on the current buying environment in the real estate market. Learn how to invest at deep discounts in real estate with your own self-directed retirement accounts.

Timothy L Taylor is currently the Executive Director of the Estate Planning Schools of America. For more information on setting up self-directed retirement accounts please contact Mr. Taylor at [email protected]

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