IRA Real Estate Investments

An IRA can legally own real estate and you can even finance properties. In this article I provide an overview of the process and provide example costs and considerations.

Note: Most of the information in this section comes from a company named Polycomp who provides custodial services for IRAs. I do not necessarily recommend this company but they did have clearly defined costs and a good FAQ. I wanted to use an actual company so I could use actual data. If you Google "self directed IRA custodial services" you will find that there are many companies who provide similar services. I only chose Polycomp so I would have representative costs and procedures. Also, prices change so only use the prices/costs shown as indicators that there are cost items that you need to investigate.

Below I listed the major points concerning holding investment real estate in your IRA.

Example Costs

Below are example costs that I believe apply when purchasing real property through a custodian. Note that these are only "guesses" and actual costs will be different.

Description Cost
IRA Setup 95
Purchase Real Property 300
Non-Recourse Loan 100
Total 495

Note that the $95 IRA setup fee is a one time fee and would not be charged again as long as additional properties are held within the same IRA account.

Non-Recourse Loans

You can finance properties purchased through your IRA. One such lender is North American Savings Bank. Some of the information in this section comes from their website.

Description 1-4 Units Multi-Family
Loan Term (Yrs) 15 or 20 15 or 20
Maximum LTV 70% SFR, 60% 2 to 4 Units 60%
Minimum DSCR 1.25x 1.3x
Item
Purchase Price 175000
Down 40%
Down Amount 70000
Loan Amount 105000
Assumed Rate 6.25%
Loan Term 20 Yrs
Payment 767/Mo
Rent 1220
DSCR 1.56

Since the DSCR is 1.56 (DSCR = (1200 x 12)/(767 x 12)) which is greater than the minimum required ration of 1.25 for single family homes this property would qualify.

Purchase Price 175000
Down % 40%
Down Amount 70000
Loan Amount 105000
Assumed Rate 6.25%
Loan Term (Yrs) 20
Payment 767
Rent 1200
DSCR 1.56

1031 Exchange vs. IRA

When I started reading about the advantages of holding property within an IRA I saw some parallels with a 1031 Exchange so I put together the following comparison. Note: the information in this section comes primary from: Patrick Rice - IRA Wealth, Second Edition: Revolutionary IRA Strategies for Real Estate Investment. Square One Publishers.

Is the tax on the gain deferred?

What is the effect of a sale?

Potential Taxes On Leveraged Profits

There is a tax on the leveraged portion of the profit called the Unrelated Business Income Tax or UBIT. The basic calculation is:

Tax = ((profit - expenses) x (% leveraged) - $1000) x UBIT tax rate.

Here is where I found the following UBIT tax table

Profit over 1000 Rate
0 - 2300 15%
2300 - 8200 345 + 25%
5350 - 8200 1107 + 28%
8200 - 11200 1905 + 33%
Over 11200 2895 + 35%

Since you only pay taxes on net gains so I doubt you will pay much (if any) taxes the first few years of ownership due to depreciation and other expenses.

Below is an example calculation of the UBIT for a sale one year after the purchase:

Description
Year 1
Purchase Price 500000
Down % 40%
IRA Investment 200000
Loan Amount 300000
Rate 4.95%
Term (Yrs) 25
Debt Service (Mo) 1745
Tax & Insurance 400
Income (Yr)
Rent 30000
Expenses (Yr)
Interest Expense 14710
Tax & Insurance 4800
Depreciation 14545
Total Expenses 34055
Net taxable Income -4055

So, no tax would be owed in this example and the -4,055 would offset other UBIT taxable income in the IRA or be carried forward to offset future UBIT taxable gains. Suppose that instead of a loss you had a $2,000 after deductions gain. The UBIT tax would be: ($2,000 - $1,000) x 60% x 15% or $90

Potential Taxes Due On Sale

Suppose you decided to sell a property that was 60% leveraged and after deducting the cost of sales and other expenses you had a UBIT taxable gain of $20,000. The tax on the gain would be: ((($20,000 - $1,000) x 60%) - $11,200) X 35% + $2,895 or $2,965

Note that if the loan is paid off 12 months prior to the sale, there is on tax since you only pay tax on the leveraged portion of the gain. Also, if you have paid down the loan to the point where you will have to start paying a meaningful amount of UBIT tax, it may be time to consider a 1031 Exchange.

Summary

The goal of this article was to provide enough information and links to resources so you can determine whether this makes sense for you. Remember that all the costs show are only representative and you need to consult subject experts before you invest.