The 3 Things You Must Avoid and The 5 Things You Must Do When Buying Real Estate in Your IRA or Pension Plan
1. Taking title in your IRA administrator’s name
Most savvy investors never put a property in their own name. The reason is very simple: you don’t want anyone to be able to go to the local court house and be able to see everything you own. Why? Potential lawsuits and liens. If something should ever go wrong with a property that gives rise to a lawsuit; the first thing an attorney will do is see if you have any assets. They do this by doing a name check on you at your local county hall. A dog bite, lead-base paint, a slip and fall – whatever; it can happen when you own property and I have had all three happen to me.
It’s even more important not to own property in the name of your IRA administrator or custodian. If something goes wrong, even if you have liability insurance, your IRA is still exposed to creditors and sue-happy attorneys.
The simplest preventative measure is to have property placed into a land trust and name your IRA administrator as the beneficiary. The trustee can be a person, or in most states an LLC, but you don’t want the administrator of your IRA or Pension Plan to be the trustee because you don’t want their name on the county records. The land trust is not a recorded document so no one knows who the beneficiary is except you, the administrator and the trustee. This is the simplest form of asset protection when buying properties personally or within your retirement accounts.
You can also sell and transfer your beneficial interest without doing a full blown closing and the recording fees that go with it. Many of the investors we know want to avoid the liability of house ownership in their IRA all together. They do this by using options, lease hold interest and equity participation notes.
An equity participation note allows you to receive net rents and future profits on a property without the liability of ownership. Your IRA affectively becomes a lender on the property and your percentage of income is identified in the note. It could be that you get 50%-90% of the income and the remaining percentage stays with the current owner or manager. Your position can be secured by a recorded mortgage or a security deed or deed of trust, depending on the state the property is located in.
2. Lack of an overall plan
If you are buying houses or holding any assets in your self-directed IRA, then you must have an overall plan. Is it cash flow? Is it upside potential? Future growth? How will you finally cash out; that is sell your assets and recoup your investment dollars plus profit?
Many well-intended investors bought properties and they never thought through the exit plan. Anyone can buy stocks, CDs, mutual funds and that is what traditional IRA custodians will do for you; like your local bank, or Merrill Lynch.
The purpose of having a self-directed IRA is so you can direct it to make above average profits utilizing other investment vehicles. Just make sure you know what you are buying and how you will get out of it so that it is worth the extra effort.
Think twice about acquiring low-income housing that requires ongoing maintenance and is management intensive. These properties are hard to insure and difficult to resell. The liability they create is not worth the potential upside you might receive.
3. Do not involve yourself or disqualified parties
For gosh sakes, never do the work on a house you buy in your IRA. That includes rehab work and property management. Stay and arm’s length away and that goes for all disqualified parties. Sub contract out everything and direct your IRA administrator to make the payments. Never use the property for personal use or any disqualified parties.
The 5 Things You Must Do If Buying Rental Property in Your IRA or Pension Plan
1. At closing, have the property deeded into a land trust
A land trust is your first line of defense for asset protection involving real estate. Once you understand the benefits of using a land trust you will never buy real estate in your name or your custodian’s name. A land trust keeps your name and your administrator and/or your custodian’s name off the public records. We live in a very litigious society and you never want the public to know what you own. It’s like having your will put on Facebook.
The trustee of your land trust should be someone or some company that you trust. Land Trust can be formed in all 50 states with minor changes in language to comply with each state. I remember the first Land Trust I created around 1988. To me, it was like a mystery because there is no reporting to the State or the Feds, you simply draw up the paperwork and have the property that you are buying deeded directly into the name of the Land Trust.
For tax-reporting purposes, the beneficiaries of the Land Trust report the income on their income tax return because the Land Trust is a flow-through entity. That is, the benefits of ownership, income, depreciation and expenses, flow directly to the beneficiary. If the beneficiary is you personally, then you report it on your personal tax return as if the deed was in your name personally. If the beneficiary is your corporation, then the corporation includes the income and/or loss on their income tax return. If the beneficiary is your IRA, there is no tax return to prepare because your IRA is either tax deferred or tax free (as in a Roth IRA). The same holds true for a pension plan. An example of how the deed should be written as grantee going into your IRA if you have a self-directed custodian could be as follows:
John Smith as Trustee for 123 Main St. Trust.
That is, of course, if your Trustee is John Smith and you can name each trust whatever you want. It doesn’t have to be the street address.
Never title a deed in your IRA or pension plan as follows:
Entrust Administration as Administrator for Joe Blow Roth IRA # 2076
By doing this, everyone in the world will know that Joe Blow’s Roth IRA owns this property and you never want the public to know your business. Keep your custodian or administrator’s name out of the public records and avoid becoming a target of some sue-happy attorney looking to line the pockets of himself and his clients because your tenant’s dog bit the mail man in the ass. Think it doesn’t happen? Guess again. I’ve had the mailman-dog-bite episode and because I used a Land Trust and had created other asset protection measures, the potential lawsuit went away because the attorney couldn’t easily find any deep pockets to go after.
2. Record a lien
Record a lien against the property. You want to protect yourself right? I sure hope so, because I’m detailing some of the best asset protection strategies that you can implement now.
This is a must if you buy property in your IRA or Pension Plan, even if you own a property free and clear. Record a mortgage, deed of trust or security deed to your trustee of a Land Trust or the property.
Let’s review: You have the cash in your IRA or Pension Plan and you want to buy a house that’s worth $125,000 for $75,000. You put the contract in the name of the trustee you are going to use and make your IRA or Pension Plan the beneficiary of the Trust. Your custodian has the paperwork to buy an asset and title it this way and if you’re still unsure how to do this; call me. My contract info is at the bottom of this letter.
So, the deed goes into a Land Trust with John Smith as your Trustee and your IRA or Pension Plan as beneficiary. Have a lien recorded against the property for $75,000 or more and have the Trustee sign it as borrower and make your IRA the lender.
This accomplishes two things:
a) Your Trustee, even though you trust him, cannot deed the property out with good title because you have a lien recorded on it. Depending on your state that lien would be a mortgage, deed of trust or a security deed.
b) Any attorney looking to sue you will go to the county records and first see who owns the house. He will then check to see if there are any liens on it. When he sees that the property had a purchase price of $75,000 and there is a recorded lien against it for $75,000 he is less apt to sue you because there is nothing in it for him. Remember, attorneys usually sue on a contingency of 1/3, which means whenever they win a lawsuit, they keep 1/3. If there is nothing to get, they look for lower hanging fruit because this isn’t worth their time or effort.
This is a practice you should follow on houses outside your IRA and Pension Plans as well. It is an advanced technique and should be an arrow in your quiver to protect the hard-earned money you’ve made for you and your family.
3. Get Homeowners’ Insurance
This is really self explanatory. I am personally not a fan of insurance of any kind because it’s a waste of money in most cases. That’s why Insurance companies make so much money and that’s why they constantly modify policies to insulate themselves from claims. In fact, I hate fire insurance. Every time I look at a house to buy I ask myself, “When was the last time this house burned, or even a house on this street?” It’s so infrequent it’s alarming.
But, you must get liability insurance in case you have a mail man walking around with some beef jerky in his pocket, hoping your tenant’s dog bites him in the ass. Believe me folks, for some people, especially low income tenants, suing someone is a way of life. In fact, on all your tenant applications it should ask if they ever sued someone. If they sued their last landlord would you rent to them? The short answer is no.
4. Use an attorney or title company to close
Never buy a house from someone and not have an accountable third party oversee the closing. In fact, have someone that has Errors and Omissions Insurance so if they do something wrong, you are protected. In most states you can either use a title agent or an attorney. This author prefers attorneys because not only do they have Errors and Omissions Insurance, but they also have a license with their state along with ethics committees on how to conduct business. Always have your money sent to them for tracking purposes and never give it directly to a seller.
5. Begin with the end in mind
If you’re not sure why you’re buying a house, don’t buy it. Look, there are plenty of reasons to buy property, but you need to consider your purpose and have a plan on how you will exit the investment. This is a great time to buy houses for cash flow. But the question is, how long do you want to own the property? In some cases, it used to be very easy to “flip” a contract or buy, rehab and sell a house. Right now, financing is tight for end users and investors alike, so if this is your strategy, it may not work. One of the keys to making a profit in real estate is to buy properties when others have to sell. Conversely, the best time to sell is when others have to buy. That being said, today’s market invokes a buy-and-hold strategy. We often hear about people buying low-priced older homes in the Northeast and Midwest. The question is; when will you sell, to whom will you sell, and what will the market be like when you do sell? If you’re buying in declining populations you had better sell sooner than later. If you’re buying in high- property tax and high-insurance states, just remember those fixed expenses will impact the value you can sell for because those expenses count against the mortgage debt service of your future “hoped for” buyer.aaa
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