Another option for those looking to invest in real estate without all the hassle, cost and time needed for investing in real property are private debt instruments. These include notes secured by deeds of trust and/or mortgages; contracts for deeds (taking over an existing loan); and corporate debt offerings. This alternative investment option matches quality real estate borrowers with investors seeking capital preservation in (at times) collateralized turn-key real estate. These investments offer diversification, control, double-digit returns and ease.

Trust deeds are often offered by a hard money lender. Hard money lenders are entities that provide funding for residential and commercial building. The economy and the strength of the financial market dictates the level in which banks and financial institutions are lending money. Hard money lenders fill the gap when a loan size is too large for a community bank and too small for large institution banks for short term financing for land acquisition or development. Reasons for considering trust deed investments:

• High demand for real estate loans: The recent credit crisis has created a high demand for specialized loans, since real estate developers are often unable to obtain the funding they need through conventional sources. As a trust deed investor, you can therefore expect a higher interest rate for the amount you lend, as well as lower loan-to-value ratios, which will significantly lower your risk.
• Less risk: Real estate developers and investors have a great deal to lose if they fail to make loan payments, so your risk as a lender is significantly less than if you were to invest in stocks. Moreover, real estate investments generally bring in highly attractive returns, since the situation is similar to when you invest in a fixed yield bond that pays off at maturity.
• Diversification of your portfolio: It is considered part of a sound strategy to divide your investments between trust deeds, equities and fixed-income investments. Real estate is proving to be a popular sector in which to invest, as are the tech and agricultural sectors.
• Greater control: You can choose the real estate project you wish to invest in.
• Speed: You may not wish to have your investment tied to a particular project for too long; with a trust deed you are looking at a waiting period of between six and 24 months.
• Simplicity: There isn’t too much to analyze, since trust deeds cover a turn-key real estate investment.
• Trust deeds yield more than bonds: Individual trust investments are considered too small to interest large corporate or government investors. Therefore, the deed market is generally monopolized by smaller investors who, with the right professional guidance, can ascertain the risk, value and expected return to be garnered from particular investments.
• The time is right: Experience has led lenders to be wary of risking over approximately 65% of market value. Moreover, most lenders are requiring safety nets like personal guarantees of creditworthiness. Finally, the significant drop in property prices recently experienced (up to 40 per cent in many cases) is not likely given current values.
• The minimum investment amount varies: Some investment firms welcome investments as low as $10,000, while others set much higher limits. This variation allows you to make a smaller investment at first, to ascertain whether or not you are comfortable with this type of investment.

Private equity, sometimes referred to as a private placement, consists of ownership interest in companies that are not publicly traded on a stock exchange. These alternative investments can be made in an existing business, a real estate venture, an investment partnership, and other areas.

Perhaps the best-known form of private equity investing is buying a stake in a new company with growth potential.

There are two primary ways in which your self-directed IRA can invest in private equity:

• Through a fund: This may include Private Equity funds or Venture Capital funds.
• Directly into a company: This means a direct investment of money into private companies.

Important things to consider when investing in private placements:

• If it is an existing entity – total ownership by disqualified individuals (including the IRA owner) cannot be higher than 50%.
• If the IRA is running a business in a flow through entity (i.e. Limited Partnership or LLC) it may be subject to UBIT (Unrelated Business Income Tax).
• The IRA owner cannot work for a business owned by their IRA.

Real Estate Investment Trust (REIT) allows an investor to diversify into many different real estate investments while earning a dividend of sort for the invested capital.  Due to the unique nature of the tax structure, a REIT is required to pass 90% of its income each year on to the investors, so the yields tend to be high relative to other investments.  There are many types of REITs however a self-directed IRA is only permitted to invest in privately held REITs.

When evaluating privately held REITs and real estate companies, conduct property due diligence by requesting a copy of the company’s annual report, prospectus and other financial information. Consider reviewing the following:

• A demonstrated ability to increase earnings in a reliable manner.
• Management teams able to quickly and effectively reinvest available cash flow as well as consistently complete new projects on time and within budget.
• Strong operating characteristics such as effective corporate governance procedures, conservative leverage, accepted accounting practices, strong tenant relationships and clearly defined operating strategies in competitive markets.

A popular investment option is direct or indirect real estate investing.

With IRA real estate investing, you can invest in property for long-term appreciation, rental income, or a short-term ‘fix & flip’. The investment properties may include; single family and multi-unit homes, apartment buildings, condominiums, commercial property, and improved or unimproved land, just to name a few.

When seeking ways to diversify your retirement portfolio, real estate may be an option.  It may provide recurring income and potential appreciation in value over time. However, real estate investing is not for the faint of heart, as you must consider allocation of your time, cost, and commitment before considering this type of investment.

Required Documents to Close a Real Estate Deal

• Preferred Trust Investment Authorization & Direction Form
• Contract or Purchase Agreement
• Appraisal or BPO
• Liability Insurance
• Property Management Agreement
• Title Insurance
• Draft of the Deed
• Settlement or Closing Statement
• Wiring Instructions

Real Estate Purchase Options

• You can co-buy real estate with your IRA funds and personal cash
• Use a blend of IRA funds and a non-recourse loan or other private lender
• Loan funds to another person and collateralize the loan with real estate

Unrelated Business Income Tax (UBIT)

If your IRA owns an asset that produces UBIT, your IRA may be subject to an UBIT pursuant to Section 511 of the Internal Revenue Code. Generally, IRA investments that can generate UBIT include any investment that incurs debt financing. Consult your tax advisor.

Investors buy tax liens for the right to collect taxes and interest from a property owner, or to foreclose on the property. Investors seek out tax liens due to the relatively low capital required, as well as the possibility of large returns. Some states don’t offer tax liens, but instead offer tax deeds. A tax deed sale is a governmental sale of real estate to cover nonpayment of taxes. These offer investors an opportunity to buy a property deed at a discount.

Can I use personal funds as a down payment on an investment property that I intend to purchase using my Self-directed IRA?

The short answer is no. Paying for the Earnest Money deposit with personal funds disqualifies the IRA. If the property is being purchased by the IRA, then the initial deposit must be from the IRA.

So what happens if I personally paid the EMD? Can the IRA reimburse me at the final closing?

When a client pays for the Earnest Money deposit with personal funds, that usually means that they’ve also signed the purchase contract and the vesting name of the buyer may not actually in the name of the IRA. If any of these scenarios are the situation you find yourself in, you should contact your custodian immediately.

An amendment to the purchase agreement will be required. The purchase contract and all documents related to the purchase must reflect the IRA as the buyer. The correct Vesting name must include the following:

Preferred Trust Company, LLC FBO John Doe Traditional IRA (account number).

Once the purchase agreement is amended then you will initial the amendment as “Read & Approved” and Preferred Trust Company will sign the amendment as custodian for the IRA as the buyer.

Next, you will need to complete the Investment Authorization and Direction form and indicate on the form the amount of money you personally sent to the Title Company for the EMD. You will need to provide Preferred Trust Company with a copy of the wire instructions for the Title company. Preferred Trust Company will process a payment from your IRA to the Title Company for money you personally paid for the Earnest Money. The Title Company will reimburse you the money you paid once they receive funds from Preferred Trust Company.

You are now compliant and can proceed with the purchase of the property!

All investment properties incur expenses; and these expenses must be paid directly from the IRA. Paying for any expenses personally for a property owned by your IRA (no matter the percent ownership) is a disqualifying event and will result in the distribution of the property to you in a taxable event.

So how do you ensure that the expenses are paid from the IRA? First, Preferred Trust Company requires every account to maintain a minimum cash balance equal to five (5) percent of the value of the property. This cash balance requirement ensures there is cash available in the account to pay for property taxes and insurance, property repairs and general maintenance, HOA dues, utilities, and property management fees. Second, become familiar with the Investment Expense Authorization forms. You will find a selection of payment options through our various expense forms. You can schedule recurring payments for annual expenses such as taxes and insurance that will automatically be paid from the IRA when an invoice is received. You can also schedule recurring payments for monthly expenses such as HOA dues and utilities. Making sure that all invoices for the property are sent to the address of Preferred Trust Company will ensure that no payments are missed.

STOP! What happens if I accidentally pay for an expense associated with my investment property? If an expense such as a water heater breaking over a weekend occurs, don’t panic! We understand that there are events that occur with investment properties that are considered emergencies and may not be within your control. The IRA can reimburse you the amount you paid personally but you must request the reimbursement within thirty (30) days of the payment being made. You will need to complete the Investment Expense Authorization and Direction form and submit the form with a copy of the invoice and payment receipt to our Accounting Department for processing.

Please select the link to access the Forms page of our website to review all the Expense Authorization form options.

Are they required? You are not required to hire a Property Management Company for your investment property; however, you may want to consider the advantages. Keeping all transactions involving your IRA owned property and yourself at an arm’s length distance is crucial. You do not want to engage in any transaction or do anything that could potentially disqualify your IRA. While you can collect rents on the property and forward them to Preferred Trust Company for credit to your IRA, you cannot personally deposit them in your checking or savings account for future credit to your IRA.  And while you can hire a maintenance company or repair servicers, you cannot personally do any work on the property. Not to mention, it can be difficult to manage a property if you do not live in the city where the property is located. For a nominal fee a property management company can provide the overarching management of the property and all transactions as well as vet renters and deal with city, county, and municipal ordinances. They also perform regular inspections on the property and rectify any violations. Most importantly, they collect rents! As you can see, having a property manager for your investment property is a good investment and ensures your IRA remains compliant. As always, be sure to do your due diligence before engaging in a contract with a company. They need to understand the IRA ownership component and your role as owner of the IRA. Once you select a property manager it is a good idea to provide the property manager with contact information for Preferred Trust Company and vice versa. Communication between the two entities is important.

It is important to differentiate between the fees and expenses associated with having an investment property owned by your IRA. By definition, a fee is an amount paid to a professional person or company in exchange for advice or services. You pay Preferred Trust Company an annual fee to administer your IRA. You can use personal funds to pay these annual fees by completing a credit card authorization form or by sending a check.

The Real Estate Asset Administration fee is assessed annually for each property owned by the IRA. The fee includes confirmation and remittance of property taxes, insurance, receipt of rents, processing of expenses, communication with the property manager and related municipalities, and compliance with IRS rules and regulations.

On the other hand, expenses in relation to an investment property are the costs associated with owning and maintaining the real estate. Expenses cannot be paid outside of the IRA. Even HOA “dues / fees” are considered an expense and not a “fee” associated with owning an investment property. You cannot use personal funds to make those payments.

Making regular contributions to your IRA will help to ensure there are funds available to pay fees and expenses throughout the lifetime of ownership of the property.

What is UBIT and UDFI and does it apply to the real estate investments I have in my IRA?

Unrelated Business Income Tax and Unrelated Debt Financed Income Tax. UBIT tax applies when an IRA receives ordinary income as opposed to passive income from the investments owned by the IRA. Rental income, interest income, and dividend income are the most common income received by self-directed IRAs and are exempt from UBIT. UBIT is due from real estate activities that are not passive in nature. For example, acquiring real estate with the intent to purchase, develop, and sell. The rate is 37% percent for any income over $12,500.00 and Form 990-T must be filed with the IRS.

UDFI tax applies to the gains received by an IRA that are attributable to debt. The tax applies when a nonrecourse loan is used to finance the purchase of property with an IRA. The gains apply to the rental income derived from that debt.

UBIT and UDFI rates are the same based on the income generated subject to a maximum of 37%. UBIT and UDFI is not triggered until $1,000.00 of income is generated annually.