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Check Book IRA?

Guest Dan Shea

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Guest Dan Shea

does anyone have experience with this concept

Her IRA is called a “checkbook IRA,” an investment vehicle created nearly 20 years ago in a landmark court ruling that essentially said: It’s your money, so you can run the show – as long as you follow the rules.

Let’s step back a moment: Not many people even know you can invest your retirement savings in real estate. But under Section 408 of the Internal Revenue Code, as long as you don’t benefit directly, you are allowed to put some or even all the funds you set aside in a tax-sheltered IRA into real estate.

They’re called self-directed IRAs because you can move your funds around. But until a 1996 court case, every step you wanted to make had to be carried out through a costly custodian. You could not take direct control. Every time you wanted to mow the grass or pay the bills, you had to pay a trustee to do it.

In the 1996 case of Swanson vs. Commissioner, the tax court gave its blessing to a new type of self-directed IRA structure – the checkbook IRA – that is much simpler than investing through a regular custodial account.

Under the checkbook format, the IRA is set up as a self-directed account that’s capitalized by funds rolled over from your current retirement account. Then, a limited liability company is created in which your new IRA purchases all the membership units. Now, your money is held in an LLC and you are ready to invest at your discretion.

“I love real estate,” she said. “I feel much more comfortable investing in tangible real estate than stock and bonds and that sort of thing. And this puts me absolutely in full control.”

Under the rules, savvy real estate investors can buy, sell and manage domestic, foreign, commercial, residential and rental properties using money invested in their tax-deferred retirement account. The funds are held in a normal business account, and as the account’s manager, you can sign contracts and write checks on the account, just as with any other business.

The speed at which you can move opens up a slew of investment opportunities, such as snapping up foreclosures or tax liens – or even a house that has just come on the market in a prime spot near the ocean or in the mountains. And, “it’s a great way for people to finance their retirement homes long before they are ready to use them.”

There still are restrictions, of course. You can’t use the property as your own residence or vacation home, and that applies not only to you but also to anyone in your family. And you can’t take money out of your IRA until you are 59 1/2 without incurring a big tax bite, just as with a regular IRA.

Otherwise, rental income is tax-deferred because it is held in a tax-deferred IRA. And there is no capital gains tax when you sell an IRA-owned property.

A few other ground rules:

• You can sell a house and purchase another one, and you can buy more than one property at a time. But any property purchased by your IRA is owned by your IRA, not you individually.

• You can invest in raw land, real estate contracts or the trust deeds that back mortgages. And if you don’t have enough money to invest on your own, you can pool your resources with others in the same boat.

• Any money used to buy a property with your IRA has to come directly from your IRA, not you personally, and you can’t be reimbursed by your IRA. This includes earnest money and closing costs, who use their retirement accounts to buy investment properties in southwest Florida.

• Similarly, costs associated with remodeling and carrying real estate need to be paid directly from your account. And any income from your properties has to flow back to your IRA.

• You cannot do business with family members, including spouses, parents, children, grandparents, grandchildren and great-grandchildren.

There are fees too. There’s a charge to set up the LLC, and you still must have a custodian. But you don’t have to pay the custodian to execute each and every move you want to make, or to collect the rent and pay the bills. Consequently, the fees are far less than investing in real estate via a typical self-directed IRA.

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Not addressing question but as an aside , it seems like you might have some potential copyright issues cut/pasting to this extent. Unless you've received premission from the source (and properly credited it), IMO you should remove all but a few of the opening sentences and then link to the source for the remaining part of the text.

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  • 3 weeks later...
  • 7 months later...

Nine months have gone by and no one has posted on this topic. Now there's a sign.

If you look at other "real estate" posts on this message board, you will see that I frequently ask the question WHY?

There are thousands of stocks, thousands of bonds, thousands of mutual funds, now over 1,000 ETFs, and probably over 1,000 REITs (real estate trusts). Some of these focus on real estate - within REITs there are ones for offices, retail, industrial, assisted living and all sort of sub specialties. So why screw around with a high cost self directed IRA/Roth pretending to be an expert on real estate? For the bulk of the folks that read this website, you just don't need to go there.

One the checkbook IRA, according to the folks pushing this....

  • Now Broad produces and sends you a customized binder. At the same time the designated custodian opens an account for your self directed IRA, and makes a request for transfer of funds.
  • Once capitalization occurs, the custodian sends you a capitalization check.
  • You take that check to your favorite bank and open a checking account in the name of the LLC.
  • Your self directed IRA is good to go. Start investing!

Wow, we get a binder! (sorry but the opportunity to make a snarky comment overcame me)

I sure would like to know how item 2 - custodian sends you a capitalization check works and why this is not considered a distribution. If the check comes to you and you touch it? Why would it not be sent t the bank? The phrase "self directed IRA is good to go" diminishes the huge issues with self-dealing, prohibited transactions, etc. Do you think the IRS might be curious that the $100 fee for mowing the lawn did not go to a relative? I can't even imagine how hard it would be to document that all transactions were done at arms length and that no hanky panky and no illegal transactions were completed.

Ten months - not a single post from someone who is familiar with this system, or has used it.

I recommend that beginning investors don't even think about real estate with an IRA/Roth. Focus you energies on making sound investment choices. Don't chase last years winners. Isn't that a hard enough assignment? If you don't know what an ETF or a REIT is, then you have basic investing eduction to work on, not real estate dreams. [ Last years winners: one of the big winners last year in the stock market were BioTech/Health companies, not so this year. In a recent Barron's article, a professional when commenting on the mistakes that investors made said that their research shows that more than a 1.5% reduction in performance can be attributed to chasing historic performance and trying to time the market. ]

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The comment about no capital gains tax seems misleading. It is true that you don't pay capital gains tax on the transaction, but since the eventual withdrawal is taxed at the higher regular tax rate, I don't see how that is an advantage.

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