FAQa About Owning Real Estate In Your IRA Or 401k

I recently put together the following list of FAQa on using your IRA or 401k to purchase real estate.

Real Estate IRA FAQ’s

Question: I’ve never heard of this before. Is it new?

No investments in real estate, non-traditional investments and LLCs have been allowed since the creation of the IRA. However, only about 2% of all IRA funds are invested outside of stocks, bonds and mutual funds. Why? Because most investors don’t know they have other options available. Stockbrokers and bankers have no incentive to explain all the options to you.

Question: Why does my current IRA brokerage firm say I can’t buy real estate in my IRA?

Custodians determine the type of assets they will hold and may not choose to hold all assets the Internal Revenue Service (IRS) allows. Life insurance contracts and collectibles are the only investment types prohibited by the IRS as an IRA investment. IRA law does not prohibit investing in real estate but trustees are not required to offer real estate as an option. So, just because your broker doesn’t offer real estate as an investment, doesn’t mean that you can’t do it; it just means that you can’t do it through that brokerage firm.

Question: Are there restrictions on the type of property that my IRA can purchase?

No. As long as it is an investment, your IRA can purchase any type of real estate (raw land, pre-development, commercial, residential, etc.).

Question: I’d like to buy a vacation home now and rent it out until I retire, then use it as my residence during retirement. Is this allowed?

No. This is a common prohibited transaction. You can never occupy a property purchased with IRA or 401k funds.

Question: Can my IRA invest in an LLC with other members?

Yes. You, any family members, their IRAs, eligible 401(k)s (or other qualified plans), and unrelated third parties may all be initial members of an LLC created to purchase real property. Each member’s interest is held separately within the LLC. Once the initial funding of the LLC is complete, however, future transactions may be limited due to the prohibited transaction and self-dealing rules.

Question: Are there going to be taxes and penalties when I move my IRA into the Self-Directed IRA?

Absolutely not! You are not taking money out of your IRA; you are transferring the assets into another type of IRA that allows you to self-direct the investment choices.

Question: At what again can I begin to withdraw money from my IRA?

You can begin at the age of 59½.

Question: I have an old 401k from a former employer. Can I roll it over to a self-directed IRA for real estate investment?

Though almost all 401k or corporate pension plans will not allow rollovers for current employees, once an employee leaves, he or she can rollover their pension plan into an IRA. The full amount does not have to be rolled over. Only move it to a self-directed account when you are ready to begin using the IRA for real estate investment.

Question: Can I buy a fixer-upper with my IRA, use the IRA money to fix it up and then be the property manager?

Yes. With the Self-Directed IRA you can do all of these things, check with your custodian to confirm they will hold the property in your IRA before you make a purchase offer.

Question: Can I contribute real estate or real estate paper to my IRA?

No. Contributions must be in cash. However, you can convert a traditional IRA that holds assets other than cash, to a Roth IRA. Some determination of value will need to be filed with the custodian to set the value of the conversion for tax purposes.

Question: Why wouldn’t I not go ahead and transfer to a true self-directed custodian?

There is no reason to move the IRA to a self-directed custodian until you are ready to start using the funds to invest in real estate investments.

Question: Can I make a loan to myself from my self-directed IRA to invest in real estate or must I use other people's IRA funds?

You cannot borrow from your own IRA personally or through entities you control. This is a prohibited transaction. Even if the money will be used to purchase an investment, neither can you personally loan money to the IRA to purchase property in the IRA.

However, you can borrow money from someone else’s IRA to fund the purchase of a property for yourself as long as that individual is not considered a disqualified person. Likewise, you could loan money from your IRA to someone who is not a disqualified person.

Question: When must I start distributions from my Roth IRA?

Unlike the traditional IRA where distributions must start at age 70½, there is no requirement to make distributions from a Roth IRA during the life of the owner. Only upon death must distributions begin to the beneficiaries.

Question: When can I begin an IRA for my child or grandchild? Are there age limitations?

Great idea! There are no age limitations, but the child must have earned income to qualify. The IRS sets some strict criteria to assure the child really did do work at a reasonable wage. Just two years of $3,000 contributions to an IRA starting when the child is 13 in an account that averages a 10% return will be over $1,000,000 when the child reaches 65!

Question: What am I not allowed to do with real estate in my IRA?

Your IRA cannot directly or indirectly buy real estate from a "disqualified person".

Who is a disqualified person?

The IRA owner;

The IRA owner's spouse, descendant (e.g., son), or ascendant (e.g., mother);

Spouse of a descendant of the IRA holder;

A fiduciary of the IRA or person providing services to the IRA (e.g., the trustee or custodian);

An entity at least 50% of which is owned (or at least 50% of the beneficial interests are held) by a combination of the above (e.g., if you and your spouse own 50% of an LLC, that LLC is a disqualified person with respect to your IRA); or a 10% owner, officer, or director or highly compensated employee of such an entity.

Question: Where can I get a non-recourse loan for my IRA to buy property?

There are at least four sources for financing which do not violate the non-recourse requirements for IRAs.

1. Seller financing. Most sellers understand that if the loan goes into default they get the property back anyway, so asking for the loan to be non-recourse should not be too difficult to negotiate.
2. Private financing from financial friends. If you cultivate a reputation as a professional real estate investor, there should be no reason that your financial friends would not loan your IRA money on a non-recourse basis, either from their own funds or from their own IRAs.
3. Banks and hard money lenders. Non-recourse loans are not the norm; so many banks will turn you down. However, there are a few banks that make these types of loans, and at least one bank, which lends in all 50 states.
4. Finally, as mentioned above, you could take over a property subject to an existing loan, provided the originator of the loan is not you or another disqualified person.

Question: Is a Roth IRA a smart estate-planning tool when I plan on leaving the assets to my children?

Yes. The Roth IRA continues tax-free compounding even after you pass away. The children can get distributions tax-free over their projected lifetimes. For example, just $30,000 left to a six-year old at a 10% annualized return will generate over $4.6 million in distributions over the child’s lifetime!

Question: What is a Simplified Employee Pension (SEP) plan?

A SEP, also known as a SEP-IRA, is a retirement plan established by an employer. A one-person business is considered an employer for these purposes and may establish a SEP. An employer can use this SEP plan to make contributions to the IRAs of eligible employees, including himself or herself.

Question: Who is eligible to establish a SEP?

Any employer, including a sole proprietor, partnership, or corporation, can establish a SEP. The corporation may either be a for-profit corporation or a nonprofit corporation. A governmental entity may also establish a SEP. When a self-employed individual sponsors a SEP, he or she is considered to be both the employer and an employee.

Question: What are Prohibited Transactions?

An understanding of prohibited transactions is very important. The IRS defines a prohibited transaction as follows: “Generally a prohibited transaction is any improper use of your IRA account or annuity by you, your beneficiary or any disqualified person. Disqualified persons include your fiduciary and members or your family (spouse, ancestor, linear descendant, and any spouse of linear descendant).” IRS Publication 590

IRC 4975 is the section that lays out the rules on prohibited transactions. Prohibited transactions generally involve one of the following: (1) doing business with a disqualified person; (2) benefiting someone other than the IRA; (3) loaning money to a disqualified person; or (4) investing in a prohibited investment. You need to make sure that it is your IRA that benefits from a transaction rather than you personally. Beware of any “self dealing” transactions.

Question: How do custodians make their money?

Each year you are charged a fee for simply having an account with a custodian. A custodian generates revenue in a variety of ways:

Asset based fees – a fee based off the value of your account holdings.

Transactional fees – a fee for processing a purchase or sale of account assets.

Holding fees – a fee on each asset held in your account.

Special fees – escrow fees, bank-wire fees, overnight mail fees.

For more info on using your IRA or 401k to hold real estate feel free to email me at don.mcgraw@tetonlanddevelopment.com or call 949-370-6737

KBR Has Strong Second Quarter

KBR Inc. on Thursday reported a nearly 40 percent increase in second-quarter net income.
The Houston-based engineering and construction company (NYSE: KBR) reported net income for the three months ended June 30, 2009, of $67 million, or 42 cents a share, on revenue of $3.1 billion, compared with net income of $48 million, or 28 cents a share, on revenue of $2.66 billion in the same quarter last year.

Analysts polled by Thomson Reuters expected KBR to have earnings of 41 cents a share.
The company also said in a statement that it had a backlog worth $12.3 billion as of June 30, and a strong balance sheet with cash and equivalents equal to $1.1 billion.
“I am pleased with the strong revenue and operating income growth over the same period last year, which contributed to KBR’s solid earnings in the second quarter of 2009,” said Bill Utt, chairman, president, and chief executive officer of KBR.

SOME GOOD NEWS: NEW RESIDENTIAL CONSTRUCTION ROSE IN JUNE 2009

New home construction rose in June, driven by a strong surge in construction starts on single-family homes, which were up nearly 15 percent from May's level, according to new figures released on July 17th, by the Census Bureau.

The increases in both building permits and construction starts surprised economists, who had predicted little or no change. Overall, building permits issued in June were up 8.7 percent from May, to a seasonally adjusted annual rate of 563,000. New permits for single-family homes were up nearly 6 percent in June, to an annual rate of 430,000. The survey covers building permits and housing starts for both single-family homes and multiunit buildings.

Overall new housing starts were up 3.6 percent in June, to a seasonally adjusted rate of 582,000 units. The big jump in single-family starts was dampened in the overall figures by a sharp drop in construction starts of multiunit buildings, which dropped by nearly 30 percent following a 60 percent increase in May. The big swing is likely the result of the survey's large margin of sampling error; the Census Bureau cautions that it may take 3-4 months for underlying trends to become reliably established.

By that measure, both new housing permits and housing starts have shown general increases since March after a series of sharp declines throughout the previous year. Both building permits and housing starts in June were at approximately half of their June 2008 levels.

- Don McGraw

Housing starts surge

By Ben Rooney, CNNMoney.com staff writer

NEW YORK (CNNMoney.com) -- Initial construction of U.S. homes and applications for building permits both surged in June, according to government figures released Friday.

Housing starts rose to a seasonally adjusted annual rate of 582,000, up 3.6% from a revised 562,000 in May, according to the Commerce Department.

Economists were expecting housing starts to increase to an annual rate of 524,000 units, according to a consensus estimate gathered by Briefing.com.

Single-family housing starts were especially strong, up 14.4% on a month-over-month basis. It was the biggest surge in that measure, considered the core of the housing market, since December 2004.

Friday's report suggests that the battered housing market is gradually stabilizing, according to Mike Larson, real estate and interest rate analyst at Weiss Research.

"The new home industry has done a good job of reducing supply," Larson wrote in a research report. "But the existing home market is still vastly oversupplied, and we continue to be inundated with an influx of distressed and foreclosed properties."

Applications for building permits, an indicator of future construction activity, rose 8.7% to a seasonally adjusted annual rate of 563,000 in June. It was the highest number of applications since December and more than the 530,000 annual rate that economists had forecast.

June marks the second month that starts have increased after the annual rate of new homes breaking ground fell to an all-time low of 454,000 units in April.

New home construction activity was strongest in the Midwest, where starts were up by 33.3% versus the previous month. In the Northeast, starts jumped 28.6% in June.

But the West and the South both saw declines in the number of new homes breaking ground last month. Starts were down 14.8% in the West and 1.4% in the South.

Mid-Year Data for Private Equity Activity in 2009

PitchBook, a private equity-focused research firm, has published its report on private equity as of the second quarter of 2009. The findings show that private equity investors continue to wait before deploying their $400 billion in available capital.

The industry appears to be rethinking the leveraged buyout and focusing on middle-market private equity deals, financed with mostly equity and little borrowing. PitchBook CEO, John Gabbert says of the report, “PitchBook’s analysis shows that the private equity industry is currently shifting gears in a return to its roots. More attention is being paid to middle-market deals using a healthier amount of equity where private equity’s operational and financial expertise can make a big difference. ”

Total Amount Invested in PE Deal Type ($M)


Key Findings from the 2009 Mid-Year Report

The first half of 2009 was the slowest six-month investment period since 2002 with only 407 completed investments, and just 174 of those were completed in the second quarter. However, another 44 deals, totaling $6.5 billion were announced during the quarter but have yet to close.

In response to the current credit markets private equity investors have been using less leverage and targeting smaller operational improvement and distressed company investments. These lower and middle-market companies now account for 70% of all investments. PE firms are also strengthening their current portfolio companies through add-on acquisitions, which accounted for 43% of all buyouts in the first half of 2009.

In Q2 2009 only the Business Products & Services and Information Technology industries were able to maintain their investment levels from the first quarter, with 54 and 29 deals respectively.

The BankUnited Financial acquisition was the largest of the quarter and accounted for over 25% of the total invested capital for the quarter.

The decrease in private equity investment is not due to a lack of available capital, which remains at an all time high of $400 billion. PE investors continue to raise capital and currently have enough dry powder to more than support the combined deal activity of 2004, 2005 and 2006 with the use of moderate leverage.

So half-way through 2009 private equity is still in a slump and investors are holding onto about $400 billion in capital.

Hedge Fund Returns Up, Redemptions Down

Tuesday, June 30, 2009

BOSTON (Reuters)—Hedge funds are living up to their high-flying reputation again with strong returns in the last three months, but many investors burned by last year's losses are clamoring for reforms before committing new money.

Final June quarter data will not be released until next week, but Merrill Lynch analysts who track returns in the $1.3 trillion industry wrote on Monday [June 29] that hedge funds will likely post their best quarterly performance since early 2000.

The rebound became visible in April when the average hedge fund returned 2.7%. It gained strength in May with a 4.4% rise, Merrill Lynch analysts wrote. For the second quarter, they estimate a gain of 6% or more.

That would mark a dramatic recovery from 2008 when the average hedge fund lost 19% and some celebrated funds, including Citadel Investment Group LLC, run by Kenneth Griffin, the 41-year-old Chicago billionaire, were down as much as 50% at the height of the financial crisis.

This year's stock rally, sparked by hopes that the worst of the global economic downturn is over, has helped boost many funds' returns.

Tudor BVI Global Fund, run by Paul Tudor Jones of Tudor Investment Corp., gained 12.4% through the end of May, while Lee Ainslie's Maverick Fund gained 8.8% through the end of May, their investors said.

"I believe there's been a very big change of mood and it has come at least three months earlier than I was expecting," said Christopher Fawcett, chief executive of hedge fund firm Fauchier Partners in London.

Last year, pension funds, endowments and wealthy individuals reacted to hedge funds' heavy losses and high fees by demanding a record $152 billion back in the last three months of 2008, research firm Hedge Fund Research said. This year, the pace of redemptions has slowed. In the first quarter, investors pulled $103 billion, according to HFR.

In May, hedge funds saw inflows of $3.4 billion, their first inflows since May last year, researchers at TrimTabs found.

"Redemptions have really dried up," said Mark Kary, chief executive of hedge fund firm Polar Capital in London, noting that his firm also saw small net inflows in the second quarter.

While inflows are still small, industry researchers said they played a critical role by letting hedge funds stop selling market positions to raise cash needed to let investors out.

"The inflows kept hedge funds from being a drain on the markets," TrimTabs President Conrad Gann said.

Pension funds and other investors have said they plan to commit more money to hedge funds in the second half of 2009, but they are also ready to attach conditions about how their money will be invested and a right to get it back fast.

"Transparency, liquidity, good fee terms, no gates, no side pockets. That is what the institutional community will be pressing hedge funds for," said Eric Goodbar, hedge fund strategist at Mellon Capital Management, a unit of Bank of New York Mellon Corp. "Hedge funds that are essentially large lockup structures will be viewed with caution."

By Svea Herbst-Bayliss and Laurence Fletcher

U.S. Investor Rose Eyes Rebound, One House at a Time

NEW YORK (Reuters)—Bruce Rose, founder of hedge fund Carrington Capital Management LLC, and a pioneer in the roller-coaster market for mortgage credit, is set for the next phase of the housing crisis: recovery.

Carrington is planning several new funds, at least one of which will step into local real estate markets expected to recover first, Mr. Rose said in a rare media interview at his office in Greenwich, Conn.

Another fund has already seen success with properties in Texas and Colorado, he said during the interview last week.

Mr. Rose is also rejecting lower estimated prices for his portfolio of homes that has grown through foreclosures, noting that fire sales by banks are exaggerating the market downturn. He is selling his properties one by one, and making much more money than rivals in the same position.

"We began to sense a bottoming of the market with the new [U.S.] administration, and began to focus on areas that we believe will recover early," he said.

The U.S. housing market is entering its third year of downturn that has triggered huge losses as homes are foreclosed and investors shun mortgages. The recession is adding to the fallout, and home prices are still sliding despite White House efforts to save 9 million homeowners with cheaper mortgages.

The pronouncement is a rare insight from Mr. Rose, 51, who left a life as aircraft mechanic and charter flight operator in 1980 to enter finance and sell ultra-safe mortgage bonds issued by Ginnie Mae, the agency that pools government-backed loans. In 1990, Mr. Rose helped engineer the first bona fide sale of mortgage credit risk at brokerage Paine Webber. Later at Salomon Brothers, he financed the early subprime lenders.

Since starting Carrington in 2003, Mr. Rose packaged $23 billion in subprime mortgages. Many of the bonds included loans originated by now-bankrupt New Century Financial, whose unit for collecting and distributing payments Mr. Rose later acquired.

Carrington kept between 6% and 12% of the riskiest parts of the securitizations, and forged unique contracts that let it direct any foreclosure and liquidations of the underlying loans.

Securitizations are now under fire from Congress, blamed for triggering the crisis by raising the money that encouraged lenders to loosen underwritings to boost volume. Their failings are a key focus of planned U.S. regulatory reforms, which Mr. Rose favors, to realign lender and investor interests.

Among the proposals, lenders are to take at least a 5% stake in what they sell, to ensure "skin-in-the-game."

"That's what we do—skin-in-the-game—and I think that's what makes us different from any other mortgage investor out there," he said.

To protect that skin, Mr. Rose is counting on his servicer, which like others, has taken the spotlight in the housing slump since its decisions can limit or increase losses to investors.

Carrington Mortgage Services has stubbornly held on to foreclosed homes through the crisis, insisting that bulk sales were hurting bonds supported by the properties. This strategy has ignited criticism from bondholders who claim Carrington is delaying sales of bank-owned properties and modifying loans recklessly to get delinquent homeowners up-to-date.

This, critics say, prolongs payments to Mr. Rose's sub-investment grade securities at the expense of the senior investors who might be made whole sooner if a home is sold. Mr. Rose says Carrington is looking out for all bondholders, as required by bond pooling and servicing agreements.

The strategy is "as long as possible, to keep the borrower in the house, and keep cash flowing to maximize the proceeds of the trust. That's always been our focus," Mr. Rose said.

When a home must be sold, Carrington does it house-by-house to get top dollar, he said.

Carrington found that as home price indexes fell, the more its selling prices outperformed the broker price opinions (BPOs) which are used by home value appraisers.

The retail market is about 15% higher than where banks are dumping hordes of unwanted inventory, which is driving home price indexes lower, he said.

Last week Carrington closed a sale in Littleton, Colo., at $277,100, 13% above two BPOs obtained in April. A home in Freeport, Texas, sold June 11 for $180,250, higher than two March BPOs of $169,432 and $130,900.

In harder-hit Florida, Carrington sold a Cape Coral house for $116,000 compared with BPOs in the mid-$90,000 range.

"We try to be the best sale on the block, not the first sale on the block," Mr. Rose said.

Mr. Rose is now eyeing East Coast and West Coast property that should perform better as markets turn. He said he expects rust-belt states and those dependent on the struggling auto industry will lag.

"As [distressed opportunities] diminish, we'll start with the origination strategy again," he said.

By Al Yoon