Wealth Through Real Estate - Using pension money to buy real estate
Wall Street brokerage firms and the mutual fund industry spend millions of dollars to make us think that investing in stock is the best way to create wealth. But did you know you can buy investment property by using money you’re saving for retirement? This month, I’ll tell you how to pay for real estate or mortgages by using your retirement savings, which are tax-deferred. I’ll bet 95 percent of Americans probably don’t even know this strategy exists.
Two years ago, Congress passed a law that lets Americans sock away profits from real estate into qualified retirement accounts such as individual retirement accounts (IRAs), 401(k) plans, 403(b)s, employee stock ownership plans and profit-sharing plans. Because Uncle Sam won’t tax this money until you retire and need to spend it, these are great savings vehicles.
“Imagine having your IRA receive all of the profits from your next deal tax-free,” said Jeffrey Desich, a principal of Equity Trust Co., an Ohio company that helps clients open IRAs for real estate investing (440-323-5491, http://www. trustetc.com/).
After the expenses of the building are paid for, the rental income flows right into your qualified account. If you sold the building, the account would grow even more. It accumulates there—tax-free—until you reach age 59 1/2, just like it would in a traditional IRA.
Frank Stevens, who started as a Dean Witter broker 23 years ago and now runs a registered investment advisory in Napa, Calif., points out that if you have a Roth IRA, your profit grows tax-deferred and you don’t even pay taxes on the back end.
Under Section 408 of the Internal Revenue Code, you’re allowed to place investment property in your retirement account as long as the property isn’t for your personal use—such as your residence, vacation home or the building in which you operate your business. It excludes property you owned before setting up the account. According to IRS rules, investors in self-directed accounts aren’t allowed to actively manage their investments. For instance, if you buy an apartment building, you’d have to use an apartment manager. If you buy a parking lot, you’d have to lease it to a parking firm to operate it. The key is that a third party must manage the investment.
To pay for real estate using retirement savings, you must set up a self-directed account with a custodian firm, also known as a third-party administrator. There are about two dozen of these companies nationwide. For an annual fee of less than 1 percent of the value of the property, these firms oversee your account just like the administrator your employer hires to take care of your 401(k). Custodian firms don’t offer investments; they handle record-keeping, and take custody of assets that flow in to your account.
You should meet with a CPA to learn about the tax issues involved. Then invest the deed to a rental house in your IRA or 401(k) plan. You could buy a percentage of an apartment building with other investors and place that partnership document into your SEP. If you’re low on money, a second strategy is to invest money from your plan to buy stock in a company you own that in turn buys properties.
Custodian companies require you to get your property appraised at least every three years. Also, the law requires you to appoint a Real Property Servicing Agent to file deeds and collect rents on behalf of your account. Most custodian firms, such as Sterling Trust Co. (800-955-3434, http://www. sterling-trust.com/), can set you up with an agent and a servicing agreement.
Uncle Sam doesn’t want any hanky-panky. According to Sterling Trust, only the custodian company can take money out of your account to pay for expenses to maintain the property such as taxes, insurance and repairs. The custodian directly pays the third party that performs the work. You can’t pay for any expenses out of your own pocket. You also cannot be paid for performing your own repairs.
If you’re wealthy, experts say it would be okay to put 25 percent of your net worth into self-directed accounts. If you’re middle class, steer 5 percent to 15 percent that way. Remember, real estate is not as liquid as a portfolio of stocks. Keep other, liquid investments in your self-directed account in case you need cash in a hurry to pay taxes and the minimum withdrawal dollars the IRS requires you to take out at age 70.
Tony Chapelle can be reached at TonyChapelle@hotmail.com, or 212-534-2002.
By Tony Chapelle