What are your investment options in a self-directed IRA?
We recently had this discussion with Tom, a client, who we met through an online discussion forum. His story may sound familiar or similar to yours. He was invested in traditional stocks and bonds through a long time friend and broker. Over the past two years, his account had not preformed badly considering the economic conditions; however, he wanted to take some of his retirement portfolio and diversify into some non-traditional assets.
You may be asking yourself, what is a non-traditional asset?
Great question!
A non-traditional asset could include, but is not limited to: Limited Partnerships, Limited Liability Companies, Promissory Notes, Precious Metals, and Real Estate.
Tom was interested in using his retirement account to purchase real estate. He was very familiar with the real estate market in his area. While he was comfortable with the real estate market in his area, the idea of using his retirement funds for real estate investments was completely new to him.
We discovered Tom’s questions about the process on a discussion board. We were glad to take time to answer his questions and eliminate his concerns.
Simply put, the process is no different than buying real property personally.
Tom opened an IRA with MyRA and moved $225,000.00 from his brokerage account to his newly established MyRA self-directed IRA.
Tom had been working with a local real estate agent to find rental property. He made the decision that he would like to have a multi-family unit. His real estate agent located a few different duplexes and quads for Tom to consider.
During the review of the cash flow, location, and conditions of the units, he discovered a duplex that was a must have. The owner had to sell the property. One unit was vacant and one was rented for $700 per month.
Tom discovered that with $5,000 to $10,000 he could make improvements to the units, and, based on the market, both could be rented at $900 to $1,100 per month.
Tom, excited at the possibility, discussed this opportunity with his real estate agent and determined that the asking price on the duplex was $206,000.00. Knowing that improvements were going to be needed, he instructed his agent to offer the seller $190,000.00.
After negotiation, Tom and the seller agreed on a price of $195,000.00, but Tom had to close in 10 days. No problem, thought Tom. His IRA was set up and funded. His $225,000.00 was just waiting for this deal.
He sent a copy of the purchase agreement to MyRA and instructed us to execute the agreement and send the down payment of $5,000.00. At the same time Tom located a local contractor to complete the property improvements. Tom is very capable of completing all the improvements on his own, he is a contractor as well, but he learned through his conversations with the staff at MyRA that he is not able to perform these improvements since this property is held inside his IRA. The updates are quoted at $7,500.00.
Two days prior to the closing date, Tom provided MyRA with all the needed documents and instructed MyRA to fund the remaining amount of $190,000.00. On closing day, MyRA had the closing documents signed and faxed to the closing agent and wired the remaining amount of $190,000.00. That was it!!!! Tom now owned his first piece of property inside his IRA.
Tom’s contractor began the needed improvements and in one month Tom was able to rent out the remaining side of the unit. He kept the rent at $700 for the existing renters and rented the second unit for $1,000 per month. He has every intention of raising the rent for the occupied unit but decided to do it in small increments.
Tom received the invoice for the improvements and sent that into MyRA with instructions to pay the invoice. Tom is excited to review his transaction.
Purchase amount $195,000.00
Improvement cost $7,500.00
Total Investment $202,500.00
Monthly Rent Proceeds $1,700.00
Property Mgmt Fee $170.00 (10%)
Monthly Expenses $510.00 (30%)
Net Monthly Income $1,020.00
Annual Income $12,240.00
Annual ROI 6%
6% returned backed by real estate is not bad at all in a tax-deferred account. But Tom converted his Traditional IRA to a Roth IRA. His financial advisor and he decided that this was a good time for him to convert. Because he converted in 2010, Tom will be able to split the tax burden over two tax years, 2011 and 2012.
His 6% is not tax-deferred it is now growing tax-FREE.
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