Why using IRA money to invest in real estate makes sense in today’s market? The Power of the Self-Directed IRA!

I have been interested for some time in writing about the topic of using Self Directed IRA funds to invest in real estate. The severe decline in the real estate values since 2006, a figure now hovering at -28.2% nationally, has made it an even more important topic to discuss. As a former licensed Financial Advisor and Registered Investment Advisor with Morgan Stanley and UBS Financial Services, I felt I was a trained and well educated professional that clearly understood all of the products we recommended to our clients. For the most part that was true, but I realized there was a clear blind spot that I discovered when I was exploring making a transition from the investment industry to the mortgage/real estate industry regarding the use of IRA funds to invest in real estate.

I remember when I first discovered that not only was it possible to utilize your retirement funds, traditionally held in IRAs or 401ks, to invest in real estate and other similar investments, but that you have been able to do so since 1974. I discussed my research with some of my fellow colleagues, and they were of the same opinion as I was under originally "that you simply can't do that". The lack of knowledge surrounding IRAs and what you were legally able to hold in them, was not done intentionally by the Advisor it just simply was not in any of the training or education provided necessary to obtain your Securities License. I followed up with our IRA department who indicated to me the same thing, but what I later discovered was that it wasn't that you couldn't use your IRA to invest in real estate and other investments it was just that you could not do it using any of the traditional investment firms whether the large "big name" firms or the online broker. It simply wasn't in their wheel house because they were not assets that a firm or the Financial Advisor could earn a commission on. So when I left the investment industry in 2002 to start a mortgage company, I was determined to explore the topic of using IRA money to invest in real estate.

So what is a "Self-Directed IRA"? A self-directed IRA is an IRA in which the account owner has control and decision-making authority over the IRA investments. "Self Directed" does not imply that there is a different set of IRA rules that govern the IRA or that it is a different type of IRA. There is no legal connotation to the term "self-directed". Self-Directed IRAs are similar to traditional IRAs except that the IRA owner is not limited to investment options of the trustee or the custodian, but instead can choose his or her investment options. What you put into your IRA is fair game, the only major limitations are that you can't purchase life insurance contracts, Subchapter "S" Corporation stock  and collectibles. The list of what you can put in them is quite extensive and did not want to bore you with what you were able to put into your IRA only what you couldn't. There are some prohibited transactions with your IRA, specifically in Internal Revenue Code 4975. That code section imposes a penalty tax on "disqualified persons" engaged in specific transactions with your IRA. These "disqualified persons" include your spouse, your parents, your lineal descendants (i.e., son, daughter). You also can't do anything that would be considered self-serving or self dealing like loaning yourself money from your Self-Directed IRA or have the Self-Directed IRA buy Real Estate or into a business you already own. I can go more in-depth, but I think you get the picture.

Now let me make my point. With real estate prices down drastically from their peak prices and distressed real estate transactions (i.e., REOs, Foreclosures, Short Sales) now making up nearly 33% of all closed transactions this market, the opportunity to acquire investment properties for the purpose of building wealth has never been greater. According to a new report by the Investment Company Institute, US retirement assets we $15.7 Trillion Dollars as of June 2010 and retirement assets accounted for 36% of all household financial assets in the US. IRAs held nearly$4.2 Trillion dollar in assets through the 2nd Quarter of 2010. However, it is estimated that less than 2% of existing IRA assets are invested in real estate. According to the US Department of Labor, over 40% of the net worth in the US in real estate. . So there is a disconnect between the amount of assets available and how much is being directed towards real estate happening that I believe comes largely from a lack of exposure to information regarding the ability to use your IRA assets to invest in something other than simply stocks and bonds. I am not arguing that you invest in real estate exclusively, but having the ability to improve your diversification in your retirement portfolio by holding actual real estate is something that can have a positive reverberating impact on your ability to achieve your retirement goals. The ability to have potentially tax-free or tax-deferred growth of your real estate investments because they are held in either IRA, Roth IRA or Solo 401k is too large of an opportunity to ignore. The power of leveraging your assets to increase your growth potential often trumps what you would obtain utilizing the same resources in traditional stock and bond investments.

I will discuss strategies and topics surrounding Self-Directed IRAs in future blogs. I strongly believe that by taking more control of your retirement assets through self-direction, as I like to say "being an active participant in your wealth creation", your ability to reach your retirement goals will be significantly enhanced. As always, please feel free to comment. I can always be reached at 206-300-2693 and terryj@jamesregroup.com or visit us at www.jamesregroup.com to learn more about the James Real Estate Group. Thanks for taking the time to read this blog.

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