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Can I Buy Rental Property With My IRA?
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Can I Buy Rental Property With My IRA? – Video
Skip: We’ll talk a little bit about IRAs and investing in real estate using an IRA. What do you mean I can invest in real estate with my IRA? Yes, you can. There are major companies that have set themselves up to facilitate your ability to do that. If you have a desire to use your IRA for real estate investment, know that it’s going to take a little time for study on your part to make sure you’re doing this properly. If you don’t do it properly and you will destroy your IRA and all the money in your IRA will become ordinary income to you at that date. It can be quite disastrous.
You need to make very sure that you’re following the rules. Once you’re following the rules and you have a good company who’s handling this for you, it can work quite well. You now have a company.
I worked with a company called Pensco in San Francisco. They do this and they’re very good at telling you what the rules are and helping you get this set up. You would put your IRA in with a facilitator, whatever their title is, and they would, in effect, be the named party in charge of the IRA. However, you have what’s commonly called checkbook control over that IRA.
The way that’s usually done is you have your IRA form an LLC and then you let the LLC handle the real estate. There are a couple of reasons for that here in California. You might not want to do that for reasons we’ve talked about. If you’ve got properties and you’re outside of California, by having the property owned by the LLC, you make your legal life much easier. Much easier to deal with people and say, “Yes, I have a property and it’s owned by this LLC.” Everybody understands basically what that means. If you say, “Well, I own this property that’s owned by my IRA.” Holy criminy.
You’ve got problems with bankers. You’ve got problems with builders. You have all kinds of issues. So that’s why most people doing this stuff actually do form an LLC specifically owned by their IRA, in order to take title to the properties. Now, because the IRA is an exempt tax entity, normally you’re making investments it’s not paying any tax. You are subject to two different types of tax. One, unrelated business taxable income, and the other is unrelated debt-financed income.
We’re talking about real estate investment here, but if you had your IRA invest in a pizza parlor and your IRA is in the business of making pizzas, that’s an unrelated business to being an IRA. Making pizzas has nothing to do with investing in some IRA. It’s an operating business. If you invest your money in an operating business, the income from that business is going to be unrelated business taxable income and you’re going to be taxed at trust rates. We’ve talked about that a little bit earlier.
Trust rates aren’t quite substantial. They jump up. The rate jumps up very, very fast. You don’t want to put yourself in that position. What you want to use your IRA for is, for example, investing in real estate. If you’re using your IRA money and you’re investing in real estate and you’re buying all cash, you don’t have any problems with these additional taxes. However, if you’re investing in real estate with your IRA and you take out a mortgage on the property, now all of a sudden you have something called unrelated debt-financed income.
The theory behind this is your IRA is tax-exempt and it’s supposed to be just doing investments and making money on the investments with the money that it’s got. If you’re using somebody else’s money, the lender’s money, in order for this IRA to make a larger profits, that additional profit amount isn’t really exempt income and you ought to be taxed on it. The way that works is if you do have– and you can run through the numbers on this before you do the transaction, you don’t want to be surprised by it at the end
Just be aware that if you’re using your IRA for investments and you’re buying debt supported property, the portion of the income that is generated by the debt and they’ve got formulas on as to how that’s all figured out, gets taxed at tax trust rates. Okay? There’s a specialist form 990T that your IRA is required to file, so your IRA or the LLC would have to get a– or the IRA would have to get an employer ID number and actually file a tax return and pay tax, strangely enough.
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