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NINE TRILLION DOLLARS
There is roughly $9 Trillion stashed away in people’s 401(k) and IRA accounts, and as we begin 2023, the S&P 500 experienced its worst loss since 2008. The benchmark index completed 2022 with a loss of 19.4%, or 18.1%, including dividends. Certainly, folks who have placed their retirement money in the market are frustrated and nervous about their returns and the unpredictable nature of their future, this might be the situation you find yourself in...
The good news is that you don’t have to settle for uncertainty in the market; there’s an investment vehicle called a Self-Directed IRA that allows you to invest your retirement account money in something that provides steady and reliable cash flow, namely, apartment buildings! Some of the benefits of leveraging a Self-Directed IRA to invest in real estate assets include: diversification of your portfolio, escaping the uncertainty in the stock market, building generational wealth, attaining financial freedom, and so much more.
SO WHERE DO YOU START?
The first step is to roll over some or all of your IRA account to a “Self-Directed IRA Custodian," who manages the funds and ensures you maintain compliance with the IRS tax laws. If you need help or a referral with this, we can connect you with a trusted professional to start this process.
A self-directed IRA is unique because of the available investment options. Below is a list of investment options available through a self-directed IRA:
Stocks
CDs
Mutual Funds
Bonds
Real Estate
Tax Lien Certificates
Mortgage Notes
Privately Held Companies
The concept of using retirement plans to invest in real estate has been around for more than three decades. The reason that you may be unfamiliar with this option is because most custodians who offer IRAs (banks and brokerage firms) focus on assets that they have vested financial interest in you choosing, such as mutual funds and CDs.
With a self-directed IRA, you’re able to invest in almost any asset. You’re able to make loans such as promissory notes or you can invest in LLCs and other corporations. Like many financial investment vehicles, there are specific regulations for IRAs, and it is the responsibility of your IRA custodian to ensure you stay compliant with these regulations.
A FEW THINGS TO CONSIDER
Certain transactions are prohibited with your IRA. Most importantly, the IRS prohibits something called “self-dealing." Self-dealing includes investments in which you or your family members of lineal descent have prior ownership.
It’s important to understand that you must have an IRA custodian before you can invest in various opportunities like real estate. Typically, it’s a financial institution such as Bank of America or Schwab that creates and manages the account to ensure compliance with the US tax codes. Not all IRA custodians are created equal, and it’s important to work with a custodian who is familiar with leveraging self-directed IRAs to invest in real estate along with the other investment vehicles previously mentioned. Again, let us know if you'd like a referral, even if it's just to get some questions answered about this process - they are very helpful and have no obligation or cost.
Some self-directed IRA custodians are easier to work with than others. Some custodians allow for investments in real estate, but they prohibit investments in syndications. Additionally, others require paper checks which we recommend avoiding because it makes the process of making distributions to investors more challenging than it needs to be. *At One-9 Holdings, we require investors to receive electronic deposits (ACH/Wire) *
Another consideration is the speed at which your custodian can execute required documents; The IRS tax code requires an “arms-length” transaction, and consequently, your custodian must sign for every transaction on your IRA. Although it is “your” IRA, it operates as its own separate entity, each time you need a document signed, there’s a formal process for submission. If your custodian requires a "wet signature" rather than electronic signatures through a platform like DocuSign, it will delay your transactions.
In short, there are significant considerations when interviewing a custodian for your self-directed IRA. First, learn how they operate, then ask your investment group’s opinion about the custodian.
HERE'S HOW THE PROCESS WORKS TO USE YOUR IRA FUNDS
Open an account with a self-directed IRA custodian.
Connect with your current IRA custodian and complete a funds transfer form. In this form, you will note the amount of money to transfer in addition to the account information of your new IRA custodian. (This process may take up to a month. So, preparation beforehand is key, especially if the investment operator you would like to invest with is under contract on a deal you like).
After your funds transfer to your new self-directed IRA account, you will complete an investment directive form that informs your new IRA custodian about the investment you want to make and gives them instructions on how to disburse the funds (by wire or check). Typically, the funds are sent directly to the title company handling your closing and are made out to the LLC that will own whatever property you’re buying. The investment will be titled in your IRA's name instead of your name.
When you liquidate the investment, the funds are sent from the title company handling the sale or refinance directly back to the IRA custodian. You will not touch any of the funds. They come from the IRA and go back to the IRA.
The ideal time to transfer your funds to your new custodian is before an active deal is present. You want to position yourself well, especially in today’s environment, where deals move quickly and you may only have a few days to wire the funds to the closing attorney.
PROS & CONS
Just like any investment strategy, there are upsides and downsides to investing with self-directed IRAs.
The clear advantage of leveraging a self-directed IRA to invest in real estate syndication deals is the return on your investment. With inflation close to 10% and with many traditional IRA accounts only earning 1-2% a year, the folks relying on their IRAs to retire are actually losing money. This fact alone makes investing with an IRA extremely valuable.
The downside to investing with a self-directed IRA is that you may have to pay taxes on your IRA due to UBIT (Unrelated Business Income Tax). UBIT generally affects investments that include a form of debt, which includes multifamily syndications. The UBIT tax law requires you to pay income tax on any portion of income that is derived from debt.
Let’s look at an example, assume you're investing in an apartment deal that is using a mortgage to finance 75% of the transaction. The mortgage is considered is a debt, which means that 75% of your profits are taxed at your current tax bracket. This taxable event for your IRA is triggered when the sponsor sells the property. Note: You need to create a tax ID for your IRA prior to it's creation. If you forget this step, you might pay a penalty and interest when your CPA files your tax returns.
THE SOLUTION?
The solution to paying taxes on your IRA is something called the “Solo 401(k).” Note: You must be self-employed to use a Solo 401(k). A Solo 401(k) is a type of Qualified Retirement Plan (QRP). This plan avoids all of these issues, meaning that you have checkbook control over the IRA and can sign your own documents. You do have to open an account, but these institutions operate like banks. You will have access to electronic funds transfers (ACH/Wires) to move money fairly quickly. You control the accounts. You sign the paperwork. It’s great!
Setting up your Solo 401(k) is a bit more expensive ($1,000 - $3,000), but it avoids the entire UBIT process and saves you tens of thousands of dollars in taxes over the long run making the set-up fee worthwhile. In addition, you have the flexibility to borrow up to $50,000 from your Qualified Retirement Plan without paying any kind of interest or penalty. You can use this for almost anything without paying a penalty, another reason why we love the QRP!
SETTING UP THE SOLO 401(K)
Getting your Solo(k) (or QRP) set up is straightforward. You will contact the provider and set up a phone call to ask you a few questions. Then, you will receive a questionnaire, and you’ll receive a document to sign. In return, you’ll receive a QRP trust document that you can now use to open up an account at a qualified financial institution.
You are now the trustee of the Qualified Retirement Plan, and you can sign documents on its behalf. After the bank account is established, you’re able to use this just like any other bank account. You’re able to deposit money, ACH, or wire money. And that’s it! It’s a very straightforward process. To ensure your process is as easy as we described, we suggest you get in touch with providers like Total Control Financial who make it easy and can answer all of your questions. We hope this blog is valuable and helps you access more investment opportunities! Let us know if you have any questions. We would love to hear from you and help you get in touch with trusted providers.
Are you ready to get started?
Click the button below to set up a time with our team here at One-9 Holdings. If you're ready to get out of the uncertainty of the stock market and if building long-term, generational wealth is something that you'd like to learn more about, we'd love to connect with you soon!
Sources:
The Complete Guide to real estate syndications for passive investors. Apartment Building Investing with Michael Blank. (2022, January 31). Retrieved December 12, 2022, from https://themichaelblank.com/apartments/complete-guide-to-real-estate-syndications/
What is a self directed Ira? Business Formations, Incorporate or Form an LLC and Protect Assets. (2020, October 20). Retrieved January 28, 2023, from https://www.companiesinc.com/grow-your-business/self-directed-ira/
Self-directed IRA investing at Equity Trust Company. Equity Trust. (2022, December 6). Retrieved December 20, 2022, from https://www.trustetc.com/self-directed-ira/