![Retirement funds such as the IRA, Roth IRA, an inherited IRA, a simplified employee pension, among others, could be eligible for investing in real estate, according to Kaaren Hall, CEO of Irvine-based uDirect IRA Services. (iStockphoto via Getty Images)
Retirement funds such as the IRA, Roth IRA, an inherited IRA, a simplified employee pension, among others, could be eligible for investing in real estate, according to Kaaren Hall, CEO of Irvine-based uDirect IRA Services. (iStockphoto via Getty Images)](https://www.pressenterprise.com/wp-content/uploads/2023/07/OCR-L-REAL-LAZERSON-0723.jpg?w=500)
Done right, short-term rentals (think Airbnb and Vrbo) can earn owners a handsome profit. So can buying traditional rentals with an eye on adding accessory dwelling units or ADUs to the residential rental property in order to further goose the profits.
Many would-be property investors struggle to come up with the down payment and closing costs, especially considering the steep home prices across California and across America are facing.
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Your motherlode of money may be hidden in plain sight.
Retirement funds such as the IRA, Roth IRA, an inherited IRA, a SEP or simplified employee pension, a SIMPLE or savings incentive match plan for employees, and a Solo-401k all could be eligible for investing in real estate, according to Kaaren Hall, CEO of Irvine-based uDirect IRA Services.
It’s important to note this does not work for building an ADU at the site of your existing home.
The best reason for considering investing in real estate instead of traditional stocks and bonds is asset diversification. It’s also an opportunity to buy property when you are otherwise cash poor.
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Over time it’s hard to go wrong with real estate.
Home prices are again rising after hitting the skids for three consecutive quarters as mortgage rates shot up. The largest profits on home sales in the second quarter of 2023 were right here in the Golden State. San Jose saw a profit of $600,000, San Francisco $416,000 and San Diego $301,500, according to Attom Data.
Where else might you invest besides California? Among big US metro areas, the largest increases in median home prices from the first quarter of 2023 to the second quarter of 2023 were found in Rochester, NY (up 20%); Madison, Wisconsin (up 19.1%); and Bridgeport, Connecticut (up18.6%), according to Attom.
Retirement fund mortgages are largely found in a finance realm separate from traditional mortgage brokers, mortgage bankers and even most depositories.
For example, the IRA lender First Western Federal Savings Bank offers loans with as little as 40% down for residential units (one to four) and as little as 50% down for short-term vacation rentals. The remaining portion can be financed.
Realistically, with higher rates and the way First Western qualifies rental income from the property, it’s likely buyers will need at least 60% down with mortgage rates starting at 8.5%, according to Roger St. Pierre, a senior vice president at First Western.
But note the cashflow qualifying requirements. First Western looks for at least a 1.25% debt service coverage ratio. This metric is calculated by dividing the annual net operating income by the annualized overhead of the investment property. This means rents must be at least 125% of the total property expenses, which includes the principal, interest, taxes, insurance and HOA fees or the total mortgage payments, management fees, a 7% vacancy factor, and a 6% maintenance factor.
Can you say mental gymnastics?
First Western’s program is available only for qualified self-directed retirement plans and LLCs made up of qualified retirement plans.
You cannot directly control the real estate asset.
Instead, one way to hold your real estate asset paid for with retirement money is in a Checkbook IRA, according to Hall. In this instance, your IRA owns the LLC.
This specialty purpose LLC evolved back in 1996. You’ll need a third-party administrator to do the tax reporting and recordkeeping.
uDirect charges $275 in annual recordkeeping and a reporting fee, plus a $50 setup fee. These fees are in-line with other administrator fees I checked.
Last I wrote about this in November 2015, First Western’s rates were as low as 4.25% or about half compared with today’s mortgage rates. The higher the rate, the more pressure to make a profit. And you can always refinance when mortgage rates drop.
Paying cash with retirement funds is better (tax-wise) than getting a mortgage using retirement funds. If you take out an IRA-type mortgage to finance a property using deferred income tax retirement funds, the IRS charges taxes of somewhere between 10% and 37% on a form called a 990-T, according to Jeff Hipshman, CPA partner at Eide Bailly. The steep tax is based only on portions of profits attached to the mortgaged money.
It’s important to note that property investors can’t touch any of the profit or the principal asset unless they’re willing to pay income taxes. The whole idea of any pre-tax investment is to allow your money to grow in a tax-deferred fund.
Once you hit age 73, you must start to take a mandatory minimum distribution from any tax-deferred retirement funds. Say you are 73 years old and the table indicates your remaining lifetime is 100 years. Let’s say the rental property and any cash in the Checkbook IRA are worth $1 million. You would divide $1 million dollars by 27 (your remaining years) for a result of $37,037, which you’d be required to pay taxes on in that first year, according to Hipshman.
Each year the third-party administrator will update the value of the asset and your remaining life expectancy to determine what that year’s RMD is. So, it can and will vary from year to year.
You can refinance and pull cash out for liquidity’s sake. Or you can always sell the property should you not have enough money in the Checkbook IRA to pay the annual RMD. Just keep the proceeds in the Checkbook IRA.
“Self-directed IRAs are great for diversifying investments beyond stocks and bonds. The right real estate investment can be a good idea, but only if the investment makes sense even without the depreciation-deduction tax benefit that often makes real estate investing most attractive,” said Rod Stern, tax and estate attorney and partner at Irvine-based Murtaugh Treglia, Stern & Deily.
“When funding a self-directed IRA, it’s important to have a game plan for how long to take distribution when you retire. When it comes time to make required minimum distributions. While it is possible to distribute partial interests in the real property each year, that may not provide the cash necessary to pay the income tax on the distribution,” he said.
Full disclosure: I do business with Eide Bailly, Hipshman and Stern.
Before trying any of these tactics to buy investment property, seek legal advice. There are very specific rules to follow to stay on the right side of potential IRS penalties for violating the rules and procedures.
Freddie Mac rate news
The 30-year fixed rate averaged 6.78%, 18 basis points lower than last week. The 15-year fixed rate averaged 6.06%, 24 basis points lower than last week.
The Mortgage Bankers Association reported a 1.1% mortgage application increase compared to last week.
Bottom line: Assuming a borrower gets the average 30-year fixed rate on a conforming $726,200 loan, last year’s payment was $583 less than this week’s payment of $4,725.
What I see: Locally, well-qualified borrowers can get the following fixed-rate mortgages with one point: A 30-year FHA at 6.125%, a 15-year conventional at 5.875%, a 30-year conventional at 6.375%, a 15-year conventional high balance at 6.625% ($726,201 to $1,089,300), a 30-year high balance conventional at 7% and a jumbo 30-year fixed at 6.625%.
Note: The 30-year FHA conforming loan is limited to loans of $644,000 in the Inland Empire and $726,200 in LA and Orange counties.
Eye catcher loan program of the week: A 30-year VA fixed rate at 5.5% with 2 points cost.
Jeff Lazerson is a mortgage broker. He can be reached at 949-334-2424 or [email protected].