Real Estate IRA Basics
When purchasing real estate with an IRA, the IRA must be listed on the contract as the buyer, and it is the custodian of the IRA and not the IRA owner who signs the contract to bind the IRA. Once the contract is ready to be signed, the IRA owner will send it to his or her self-directed IRA custodian with a direction of investment form, instructing the custodian to sign the contract for the IRA. In most instances, the custodian of the IRA will require the IRA owner to sign the contract as "read and approved" so that the custodian is certain that the IRA owner has read the terms and approved them for his or her IRA. Remember that the IRA is buying the property and not the IRA owner, so all contracts must be signed by the IRA custodian, who is the only party that can legally bind the IRA.
All funds due by the buyer and relating to the purchase of the property must be paid by the IRA, including: earnest money, deposit or down payment, closing costs, inspection and due diligence costs, and the final funds necessary to close the property. Since the IRA owner is a disqualified person to his or her own IRA, the IRA owner (and any other disqualified person) cannot make the earnest money deposit and cannot cover other expenses to the property with personal funds outside of the IRA.
The purchase contract for a property cannot be assigned from a disqualified person to an IRA. Similarly, the IRA cannot assign a property to the IRA owner or other disqualified persons. Assignment of a contract between an IRA and a disqualified person is a per se prohibited transaction.
A real estate contract could be assigned to the IRA from someone else who is not a disqualified person; conversely, any assignment from a disqualified person will likely constitute a prohibited transaction. In the event that an IRA owner mistakenly enters into a contract in their personal name, then the IRA owner should seek to unwind the contract in his or her personal name with the seller and should obtain a new contract, properly listing the IRA as the buyer. Any earnest money or deposits made by the IRA owner personally should be returned to the IRA owner personally and the IRA should then bear those expenses and contract requirements in the new contract.
If the contract cannot be undone in the IRA owner's personal name, then an addendum to the contract can be added, clarifying that the buyer is the IRA. The addendum should no transfer or assign the contract but shall instead clarify who the buyer is.
If the IRA is going to be on title to real property with other owners, then the multiple-party form of ownership must be tenants in common. Other forms of multiple-party title ownership, such as joint tenancy and tenants by the entirety, should not be used because those ownership interests have characteristics whereby ownership passes to the other party on title following the death of the owner. Because the IRA cannot die and because the IRA's ownership following the death of the IRA owner is determined based on the IRA beneficiary designations, the IRA's ownership cannot be transferred via joint tenancy or survivorship methods. Tenants in common, on the other hand, is a form of holding title whereby upon the death of an owner, the title to their ownership passes to his or her heirs. In the case of the death of the IRA owner, the heirs to the IRA pursuant to the IRA beneficiary designation forms will receive the ownership to the property. This change of ownership upon death of the IRA owner may occur by an inherited IRA to the beneficiary or via distribution to the beneficiary.
When IRA-owned property is held for rent, it must be structured such that rental income is recieved by the IRA, and expenses are paid by the IRA. The IRA owner and other disqualified persons cannot personally be the "middle man" by paying expenses personally or by collecting the rent in their personal account and then forwarding the funds to the IRA. This is the primary reason Done For You Real Estate advocates utilizing a property manager to collect the rents from the property.
The IRA hires a property manager, which is already selected and a relationship forged through the DFY investment system, and that property manager manages the property and receives the income and pays property expenses. Cash flow is returned to the IRA. The property management company cannot be a disqualified person to the IRA owner, and the property management company will typically take a percent of the rental income collected as payment for their services. DFY Property Management companies typically collect between 8% and 10% of the gross monthly rent. Under this method, the IRA enters into an agreement with the property management company, and the property management company then enters into leases with respective tenants. The IRA receives rental income minus property expenses and fees charged by the property management company.
When managing IRA investment assets, the IRA owner should limit his or her activities to administrative and investment oversight tasks. While it is permissible to administer the investment, it is generally viewed impermissible to physically work on investment assets like real estate since such actions can constitute a per se prohibited transaction or a self-dealing prohibited transaction.
While it is permissible to make decisions as to the property manager or tenants and making decisions like when to buy and sell and at what price, etc., it is not permissible to take title or enter into contracts in the IRA owner's personal name as opposed to the IRA.
While it is permissible to set terms for the lease or other legal agreements (assuming the property is owned directly by the IRA and any contract must be signed by the IRA custodian), it is not allowed to receive rental income in the IRA owner's personal account or paying IRA expenses from a personal account of the IRA owner.
While it is permissible to visit the property and oversee repairs and maintenance, it is not okay to physically work on the property, or have any work done by the IRA owner or any other disqualified person.