Real Estate LLC Roth IRA?

[Guest seanof30306]

I'm interested in finding out more about Real Estate Roth IRAs. All the information I've been able to find so far has been on websites of companies that want to sell me something, so I'm a little leery of it.

The first question I have is, can you do a Roth Real Estate LLC IRA, or are they only traditional IRAs? If so, I have a Roth IRA that I'd be interested in converting to a Real Estate LLC IRA.

Can anyone direct me to informational resources on this?

Thanks

[J Simmons]

Good to be leery. There are special concerns when investing the assets of an IRA (Roth or Traditional) in real estate to avoid 'unrelated business taxable income' and/or prohibited transaction by reason of the real estate investment. The assets of a Roth IRA may be invested in real estate, but there are significant limitations and risks. There's no conversion from "Roth IRA" to "Real Estate Roth IRA" except that the Roth IRA's assets are invested in real estate.

[Guest seanof30306]

Good to be leery. There are special concerns when investing the assets of an IRA (Roth or Traditional) in real estate to avoid 'unrelated business taxable income' and/or prohibited transaction by reason of the real estate investment. The assets of a Roth IRA may be invested in real estate, but there are significant limitations and risks. There's no conversion from "Roth IRA" to "Real Estate Roth IRA" except that the Roth IRA's assets are invested in real estate.

Thanks for the response. Where would I go to get more information on this?

[J Simmons]

Take a look here

[Guest seanof30306]

Take a look here

Thanks for the help.

One thing he says which appears to conflict with what I'm finding elsewhere is that rental income is/may be taxable. Everything else I'm finding on this (admittedly from people who want to sell me something) says rental income, or any profits, for that matter, are not taxable, as long as they stay in the IRA.

Here's my situation. I'm 51 years old. After a total financial crash and burn in 2002, I got all the debt repaid and started over in 2006. My employer matches 6% in my 401K, so that's what I contribute there, placing it in the Fidelity Freedom 2025 targeted retirement fund. I've maxed my Roth contributions for 2006, 2007, and 2008, and now have about 15,500 in it. I'm also saving everything else I can, with the intention of buying a small home before July 1, 2009 in order to take advantage of the 7,500.00 tax credit offered by the Mortgage Relief Bill. That home, by the way, is for personal use; I know I can't use a Real Estate IRA to purchase it.

With my Roth, even if I continue to make the maximum yearly contribution, I just don't think I have enough time till I retire to grow it enough. If I take a conservative route, and invest in CDs, even at the great rates I see on long-term CDs, there isn't enough growth. I can get 7 year CDs right now, for example, at returns as high as 6-6.5%, but there's no way I can expect to average that rate of return until I retire. As the economy recovers, those rates will fall.

If I take a riskier road and go into the stock market, the short time I have until retirement still means I'll have to average an unrealistic rate of return to be able to grow that Roth into an entity that can offer any real income at retirement. That leads me to think I need to look at other avenues.

It's clear you're not a fan of Real Estate IRAs. You also clearly know a lot more about them than I do, but here's my thinking on it. Maybe you can show me where I'm wrong.

In Tulsa, where I live, the real estate market is down, but nowhere near as much as the national average. This holds especially true for the part of town I live in. It's an area built in the 30s, 40s, and 50s, and has been a hot remodel market for the past 10 years, and it's actually heating up. Right in the heart of this area are some small condos. A year ago, they were going for 40-45,000. Today, they're going for 55-60,000, as the horrible dump of an apartment complex next door to them has been torn down, and a luxury apartment complex is going up in their place. I believe the prices are also going up because people who found themselves in too much house when their ARMs adjusted appear to be downsizing into them.

I already plan to buy one of these as my personal residence. With what I'm currently spending on rent, i can pay the mortgage on the condo, the property taxes, the insurance and HOA fee, and make monthly principal reduction prepayments that will pay the loan off in 11.4 years. That seems a pretty good personal investment to me.

If I were to convert my Roth to a Real Estate IRA, I could purchase two of these condos as turn-key rental units right away, putting 10% down on each. Assuming 11 months' rental income per year, and leaving all rental income in the IRA, I would be able to pay them off in less than 15 years. With the 6,000.00 I contribute to the IRA yearly, I could also purchase several more units in the future.

Assuming 4 units paid for in retirement, I've run the numbers in today's dollars.

These units rent for 650.00 per month. 11 months' income per year would be 7,150.00

HOA fees are 1,500.00 per year.

Property taxes are 560.00 per year.

Insurance is 525.00 per year.

Budget 500.00 per year for maintenance and upkeep (All external maintenance and upkeep is covered by the HOA fees)

That leaves 4,065 in profit per unit, per year. Four units yields 16,260.00 per year. I'd also have four wholly-owned pieces of real estate which could be sold or reverse-mortgaged. Given my circumstances and time until retirement, I just don't see how I can make that money work more efficiently for me.

What am I missing?

[J Simmons]

Debt-financed investments lead to unrelated business taxable income for an IRA.

Real estate management--if the IRA does not hire a company to do that--can lead to unrelated business taxable income too.

What you describe doesn't sound like it involves a situation of any personal use, by you or your family members, directly or indirectly. So you would likely not run into prohibited transaction issues unless there are other relevant factors.

Actually, I'm a fan of IRAs investing in real estate. Navigating the unrelated business taxable income and prohibited transaction rules, either to help an IRA owner steer clear of tax problems or in helping to remedy (to the extent possible) a situation gone bad is a great source of revenue for me. I'm a fan of any tax savings angle handled correctly.

[GBurns]

I did not see any provision for mortgage repayment in your numbers. That should reduce your $4,065 profit per year.

[Guest seanof30306]

Debt-financed investments lead to unrelated business taxable income for an IRA.

Real estate management--if the IRA does not hire a company to do that--can lead to unrelated business taxable income too.

Can you expand on these, please?

[Guest seanof30306]

I did not see any provision for mortgage repayment in your numbers. That should reduce your $4,065 profit per year.

The 4065.00 profit per unit, per year was an example, using today's numbers, as if I were retiring today, with the units paid for.

Obviously, rents, HOA fees, property taxes and insurance will be higher in 2025, but I'm assuming they will have kept pace with inflation.

Using a Roth IRA calculator, if I'm able to earn 5% with my Roth, and continue to contribute 6,000.00 per year into it, I'll end up with 182,877 in 2025, allowing me to take 9143.85 out per year, assuming I continue to earn that 5% (a pretty big assumption)

If I earn 7.5%, I end up with 236,851 in 2025, but by that time, I'll definitely need to have it in safer investments, so I don't think I can assume any more than a 5% return from that point forward; 11,842.55 per year.

The fact is, I don't hit that 16,000 per year return (after 2025) from my Roth unless I earn 10.5% annualy with it until 2025, and 5% per year afterwards.

Additionally, that 16,000.00 per year return is at todays numbers. It's reasonable to assume those numbers will be higher in 16 years, isn't it?

[J Simmons]

Debt-financed investments lead to unrelated business taxable income for an IRA.

Real estate management--if the IRA does not hire a company to do that--can lead to unrelated business taxable income too.

Can you expand on these, please?

From that previously linked write-up, there is this paragraph:

The UBTI rules apply to IRAs and qualified plans because they are tax exempt. The trap in the real estate context is that there is a special kind of UBTI that is generated from "debt financed property." This means that if the real estate is mortgaged (and what commercial real estate isn’t?), the rental income generated may be UBTI. The plan or IRA must then pay income tax.

Section 514 of the Internal Revenue Code is the one to look at.

[Guest Wagner]

Debt-financed investments lead to unrelated business taxable income for an IRA.

Real estate management--if the IRA does not hire a company to do that--can lead to unrelated business taxable income too.

Can you expand on these, please?

From that previously linked write-up, there is this paragraph:

The UBTI rules apply to IRAs and qualified plans because they are tax exempt. The trap in the real estate context is that there is a special kind of UBTI that is generated from "debt financed property." This means that if the real estate is mortgaged (and what commercial real estate isn’t?), the rental income generated may be UBTI. The plan or IRA must then pay income tax.

Section 514 of the Internal Revenue Code is the one to look at.

I've been following the discussion of converting the Roth IRA to a self-directed real-estate IRA. I was hopeful that my Roth IRA, a money-market account, could purchase vacant land which my wife owns or land which she and I own together. We would then intend to sell the land at a profit at a later time and hope to realize a tax-free gain upon the sale. From the discussion, I conclude that this would be prohibited inasmuch as we are "related parties." If the land were owned by an Educational Trust for which we were directors, would this be an approvable arrangement? Thanks for any guidance you may be able to provide.

Wagner

[K2retire]

Most likely any entity in which you have the ability to control things (like being a director) is going to be related and therefore prohibited.

[J Simmons]

Debt-financed investments lead to unrelated business taxable income for an IRA.

Real estate management--if the IRA does not hire a company to do that--can lead to unrelated business taxable income too.

Can you expand on these, please?

From that previously linked write-up, there is this paragraph:

The UBTI rules apply to IRAs and qualified plans because they are tax exempt. The trap in the real estate context is that there is a special kind of UBTI that is generated from "debt financed property." This means that if the real estate is mortgaged (and what commercial real estate isn't?), the rental income generated may be UBTI. The plan or IRA must then pay income tax.

Section 514 of the Internal Revenue Code is the one to look at.

I've been following the discussion of converting the Roth IRA to a self-directed real-estate IRA. I was hopeful that my Roth IRA, a money-market account, could purchase vacant land which my wife owns or land which she and I own together. We would then intend to sell the land at a profit at a later time and hope to realize a tax-free gain upon the sale. From the discussion, I conclude that this would be prohibited inasmuch as we are "related parties." If the land were owned by an Educational Trust for which we were directors, would this be an approvable arrangement? Thanks for any guidance you may be able to provide.

Wagner

In addition to what k2retire mentioned about controlling an entity, if you prearrange a sale by the entity to the IRA before your wife (or you and your wife) sale to the entity, it would be a prohibited transaction even if you do not control that entity.