When using a Self-Directed IRA for buying investment land there are a number of ways you can structure the transaction:
- Use your Self-Directed IRA funds to make 100% of the investment
If you have enough funds in your Self-Directed IRA to cover the entire land investment purchase, including closing costs, taxes, fees, insurance, you may make the purchase outright using your Self-Directed IRA. All ongoing expenses relating to the real estate investment must be paid out of your Self-Directed IRA bank account. In addition, all income or gains relating to your real estate investment must be returned to your Self-Directed IRA bank account.
- Partner with Family, Friends, Colleagues
If you don’t have sufficient funds in your Self-Directed IRA to make a real estate purchase outright, your Self-Directed IRA can purchase an interest in the property along with a family member (non-disqualified person – any family member other than a parent, child, spouse, daughter-in-law, son-in–law), friend, or colleague. The investment would not be made into an entity owned by the IRA owner, but instead would be invested directly into the property.
For example, your Self-Directed IRA could partner with a family member (non disqualified person – any family member other than a parent, child, spouse, daughter-in-law, son-in–law), friend, or colleague to purchase a piece of property for $150,000. Your Self-Directed IRA could purchase an interest in the property (i.e. 50% for $75,000) and your family member, friend, or colleague could purchase the remaining interest (i.e. 50% for $75,000).
All income or gain from the property would be allocated to the parties in relation to their percentage of ownership in the property. Likewise, all property expenses must be paid in relation to the parties’ percentage of ownership in the property. Based on the above example, for a $2,000 property tax bill, the Self-Directed IRA would be responsible for 50% of the bill ($1000) and the family member, friend, or colleague would be responsible for the remaining $1000 (50%).
- Borrow Money for your Self-Directed IRA
You may obtain financing through a loan or mortgage to finance a real estate purchase using a Self-Directed IRA. However, two important points must be considered when selecting this option:
Loan must be non-recourse – A “prohibited transaction” is a transaction that, directly or indirectly involves the loan of money or other extension of credit between a plan and a disqualified person. Normally, when an individual purchases real estate with a mortgage, the traditional loan provides for recourse against the borrower (i.e., personal liability for the mortgage). However, if the IRA purchases real estate and secures a mortgage for the purchase, the loan must be non-recourse; otherwise there will be a prohibited transaction. A non-recourse loan only uses the property for collateral. In the event of default, the lender can collect only the property and cannot go after the IRA itself.
Tax is due on profits from leveraged real estate – Pursuant to Code Section 514, if your Self-Directed IRA uses non-recourse debt financing (i.e., a loan) on a real estate investment, some portion of each item of gross income from the property are subject to Unrelated Business Income Tax (UBTI). “Debt-financed property” refers to borrowing money to purchase the real estate (i.e., a leveraged asset that is held to produce income). In such cases, only the income attributable to the financed portion of the property is taxed; gain on the profit from the sale of the leveraged assets is also UDFI (unless the debt is paid off more than 12 months before the property is sold). There are some important exceptions from UBTI: those exclusions relate to the central importance of investment in real estate – dividends, interest, annuities, royalties, most rentals from real estate, and gains/losses from the sale of real estate. However, rental income generated from real estate that is “debt financed” loses the exclusion, and that portion of the income becomes subject to UBTI. Thus, if the IRA borrows money to finance the purchase of real estate, the portion of the rental income attributable to that debt will be taxable as UBTI.
For example, if the average acquisition indebtedness is $50 and the average adjusted basis is $100, 50 percent of each item of gross income from the property is included in UBTI.
To learn more about land investment and purchasing land through a Self-Directed IRA, contact a member of the 9 Core Realty Team at (239) 333-2221.
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