Not every Real Estate deal involves immediate ownership. Optioning a property is one way to temporarily tie up real estate until the investor decides to exercise the option and cash out the seller.
In my opinion, this is a perfect strategy for a self-directed IRA for two reasons:
1. Little cash is invested out of the IRA versus a much larger amount should the IRA acquire the real estate directly.
2. Options can be assigned, giving the investor choices on acquiring the property versus selling or assigning the option for a profit.
An option gives the investor the ability to purchase a property for a set price within a set period of time. If the investor doesn’t want to exercise his option, he is generally only out the down payment he put into the option. Most investors shoot for the lowest amount possible as an option consideration. The investor, in this case the IRA, leases the property for the same time period the option is good for. This gives the IRA positive cash flow tax-deferred or, in the case of a ROTH IRA, tax-free for that time period.
Let me give you an example of optioning real estate in a Self Directed IRA:
John Doe finds a property in North Carolina that is selling for $120,000. The owner agrees to allow him to lease option the property. John’s IRA puts up $1,000 as an option consideration. The IRA then rents the property from the owner for $850.00 per month for one year with a renewable one-year lease period.
John finds Sue who wants to rent the property and possibly buy it from John’s IRA. The IRA rents the property to her for $1,000 per month. The IRA receives a $150.00 per month positive cash flow. The property then goes up in value to $135,000. Sue negotiates with John’s IRA which agrees to sell her (assign) the option for $10,000.
Sue buys the property directly from the original seller using the option consideration that John’s IRA assigned to her. This allows Sue to acquire the property for less than fair market value. Sue pays a total of $130,000 versus $135,000.
John’s IRA receives $1800 for a year of positive cash flow plus $10,000 for the assignment of the option. Total earnings are $11,800 for a $1,000 investment, not a bad return for a year. In addition, the profit is tax-deferred or, in the case of a ROTH IRA, tax-free!
Everyone wins! The seller sells his property, John’s IRA makes a profit and the new buyer Sue acquires the property at a discount.
To protect the investor he/she will need to make sure the following is in order:
1. The right to sublet the property.
2. The right to assign the property.
3. The right to record the option in public records.
4. A good lease and a good sales agreement.
With any investment, it is good paperwork that makes all the difference. With education an IRA can accumulate wealth with low dollars as long as the IRA owner knows and understands the investment. Our clients have been very successful with this strategy. For more questions regarding how to do lease options in your self-directed IRA, visit us at www.irainnovations.com to speak with one of our experienced staff.