With a self-directed IRA, you have the option to invest your money into many more asset classes than just stocks, bonds, mutual funds, and CDs (certificates of deposit). This includes alternative investments such as tax liens, precious metals and cryptocurrencies.
Today we’re going to look at your options for investing in trust deeds in your IRA, and some of the details and tips that you should know to get through the process.
In this article:
- Rules for Investing in Real Estate with Your IRA
- Advantages of Real Estate Investments in Your IRA
- Disadvantages of Real Estate in Your IRA
- Tips for Putting Real Estate in Your IRA
- Mortgages and Trust Deeds in Your IRA
- Tips for Putting Mortgages in Your IRA
Mortgage and Trust Deeds | How to Invest in Them Using Your IRA
Trust Deeds Definition: It is a legally binding document that shows both the lender and the borrower agree to let a neutral third party or a trustee hold the property title. This arrangement serves as a form of security for the lender while the borrower repays the debt. The trustee holds the property title while the borrower keeps the actual asset unless the conditions are stated differently in the deed.
Rules for Investing in Real Estate with Your IRA
If you decide to include real estate, such as a mortgage, in your IRA, you need to follow these rules:
- Buy at arm’s length — This means you can’t use your IRA to buy real estate from yourself or your family members. You must have an “arm’s length” relationship with the seller.
- Don’t buy the real estate for personal use — You and your family can’t live in the home, vacation on the property, or utilize it for any other personal need.
- Do not borrow — You, your spouse, the IRA trustee, and any business in which you have more than a 50% stake, can’t borrow from the portion of the IRA based on real estate.
- Avoid using the real estate as collateral on a personal loan — You may be able to get a particular non-recourse loan as long as you don’t sign the documents.
Advantages of Real Estate Investments in Your IRA
Like any investment, real estate such as a mortgage in your IRA has some pros and cons. The main benefit is you can defer taxation. If you meet the income guidelines and your employer doesn’t offer a 401(k), you can invest up to $5,500 into an IRA every year. You can then claim the amount as an income tax deduction.
As the property grows in value, you don’t have to worry about capital gains tax. Similarly, if you sell it, the funds go into your IRA. You don’t need to settle income tax on them. You only do so when you withdraw from the funds. If you leverage your mortgage to get a loan, you may face additional tax requirements due to the unrelated business tax (UBT).
Unrelated Business Tax (UBT) Definition: It is a tax levied on an income-generating activity of a tax-exempt entity.
Note these tax rules apply to a Traditional IRA. With a Roth IRA, you don’t claim a tax deduction for your contributions. In exchange, you don’t have to pay any income tax when you withdraw from the account during your retirement.
Disadvantages of Real Estate in Your IRA
You have to keep cash reserves in your IRA to cover property upkeep and expenses. You can’t charge the costs to your account. In most cases, you can’t manage the real estate by yourself. You need to hire someone to do it, and the wages must come from your IRA.
If other people use the property, you may be liable if injuries occur. When that happens, the injured party may go after the other assets in your IRA.
Tips for Putting Real Estate in Your IRA
To minimize and even eliminate the downsides mentioned above, you may want to purchase raw land rather than improved property. Generally, raw land doesn’t depreciate. You can also subdivide the land and sell at a markup. Additionally, you don’t have to worry about slip-and-fall accidents because people won’t need to be on your property.
Many people also use their IRA to buy houses they can flip. It allows them to sell without having to think about the capital gains. When you make a sale, the funds go into your IRA, and they are not taxable. To reduce liability issues, you may want to set up a limited liability corporation (LLC) in your IRA. Then you use it to purchase real estate.
Mortgages and Trust Deeds in Your IRA
You may also want to put some mortgages or trust deeds in your IRA. Also, you can lend money directly from your account or use it to buy mortgage notes from brokers or private parties. In both cases, these are debt securities. As the borrower repays the loan and interest, you earn money on your investment.
To lend money to a borrower from your IRA, you need the following elements:
- Buy Direction Letter — You can get this form from your IRA custodian. There is a general buy direction letter, a real estate buy direction letter, and a buy direction letter for real estate notes. If you’re lending money, you need the real estate note buy direction letter.
- Promissory Note — This document explains the essentials of the loan.
- Trust Deed or Mortgage Deed — The deed of trust explains the borrower or the lender (your IRA account) does not hold the property. Instead, a trust acting as a neutral third party does.
- Lender’s Preliminary Title Report — This report contains all relevant details about the property’s title and ensures there are no liens.
Tips for Putting Mortgages in Your IRA
To avoid problems, you may want to work with some investors. Then, you can split several mortgages between all your accounts rather than deal with an entire mortgage on your own. Also, pay attention to the value of the property.
If the lender defaults on the loan, your IRA may end up owning it. You should be able to sell or rent it out. You may even want to go through the steps to transfer the property from the IRA to your name. If the property is lackluster and low value, selling or taking over ownership may not be possible or desirable.
A self-directed IRA gives you a host of possibilities you can’t get from a conventional IRA. If you’re looking for a way to diversify your portfolio, you may want to explore trust deeds and real estate including a mortgage. Inside Your IRA wants to ensure that the value of alternative investment choices is understood by its readers. This blog is created for readers to get information and resources they need to make strong investment decisions.
What do you think about investing in a mortgage using your IRA? Would you like to do it? Share your thoughts below!