As we learned in this post, you can use your IRA to purchase real estate as an investment. We know that IRAs are legal entities apart from their owners. What this means is that as a legal entity, your IRA can partner with any other legal entity to make a real estate purchase.

Since this it’s a little nebulous talking about IRAs as entities and how people can use them, let’s look at a case study with Scott Andrews to better explain how a situation like this might work.

Scott wants to purchase 65 acres of land in Coosa County as an investment in his IRA. The property is listed for $125,000.00, but Scott only has $85,000.00 in his IRA.

Since Scott is a legal entity with funds in other types of accounts and his IRA is a separate legal entity, he can partner with his IRA to purchase the land. Put another way, Scott decides to partner with himself.

But is that legal? Are we sure it’s not a prohibited transaction? A prohibited transaction is when you buy and sell between yourself and your IRA. Since the land is owned by another party, this is an arms-length transaction, and two legal entities are coming together to purchase the property.

Scott already has an account with IRA Innovations that has $85,000 in his IRA. Here is how he would complete the purchase of the land.

He decides the IRA will own 60% of the land, and he as an individual will own 40%. With that in mind, he enters into a contract with the owner of the land. The contract is in his name and the name of his IRA.

Next, he completes a buy direction letter with all the information about the transaction and sends the letter and the contract to IRA Innovations. We sign the contract on behalf of the IRA and send it to the real estate agent. We then call the closing attorney and inform her that one of the buyers is an IRA and that IRA Innovations will sign all the closing papers on behalf of the IRA.

When the closing date approaches, the attorney sends all the documents to us to sign. We review all the documents and make sure they are titled correctly.

IRA Innovations makes sure Scott has seen all the documents and approves them. We sign the documents on behalf of the IRA, send the documents back to the closing attorney, and wire the attorney $75,000.00 for the IRA’s portion of the purchase. Scott also signs the documents and sends his $50,000.00 to the attorney for his portion of the purchase.

The process we just described really isn’t much different than making a real estate purchase personally. The only difference is that there is an intermediary, such as IRA Innovations, performing the transaction on behalf of the IRA.

One other difference to note is a reminder that the IRA is responsible for 60% of the expenses associated with the investment. This means enhancements like adding fencing, cutting roads, and property taxes.

So what happens if there is a shortage of money in the IRA for these types of expenses? Scott has a few options. He can make a contribution to his IRA, which is the easiest option. However, he is limited in the amount he can contribute, so there may be some restrictions. For example, if he can only contribute $6,000.00, and that is not enough to meet the expenses, Scott could make what is called an excess contribution. Penalties of 6% of the amount he over-contributed may be assessed for each year the excess contribution remained in his IRA.

Scott could also move funds from another IRA or 401(k) Plan if those funds were available. Another option would be selling all or part of another asset in his plan and using those proceeds for the IRA.

Bringing in other partners might be the last option for Scott to consider as it’s most likely the more complicated choice. This involves going through another sale for the new partners and would result in his IRA giving up an undivided interest in the property since a totally new entity would be involved.

IRA Innovations provides self-directed retirement account administration and education. As the experts when it comes to “alternative” investments including real estate, they can provide the necessary tools and information to get started with a real estate IRA.  

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