Using Your IRA to Invest in Real Estate

Did you know that you can use your IRA to invest in real estate? In a traditional IRA, you invest in a fund comprised of stocks, bonds, and other common types of investments chosen by a plan administrator. With a self-directed IRA, investors have the freedom to pick the exact assets that they’d like to hold in their account. That can include REITs (real estate investment trusts), or even entire properties.

In order to add real estate to your self-directed IRA, you will need to work with an IRA custodian, which is a person or company who will manage your IRA. Not all custodians are created equal, and they will differ on the types of investments they can handle, so you may have to talk to a few of them to determine if they are experienced with REITs or using an IRA to purchase property.

REITs

REITs vary in size and nature but tend to be comprised of large commercial and residential properties. While REITs are often traded on the stock market, they don’t reflect ownership of a company like a stock does. When you invest in REITs, you’re purchasing pieces of buildings. This means they will be subject to the same booms, busts, and fluctuations of real estate, including the ability to hedge against inflation. In times of high inflation, when rents and property values increase, the value of REIT shares will also increase.

Buying property

When you buy a property using your IRA, the IRA is the buyer acting on the investor’s behalf. Purchasing real estate through an IRA usually means being a cash buyer, because securing financing to purchase property inside an IRA isn’t easy. Therefore, the buyer’s IRA balance will have to be high.

The IRA custodian completes the purchase by wiring the funds, including all closing costs, from the buyer’s account to escrow. The IRA now owns the property. The title to the property will read something to the effect of “John Doe Trust Company Custodian [for benefit of] (FBO) [Your Name] IRA.” Once you rent out your property, the lease agreement with the tenant is signed by the self-directed IRA custodian, and rental payments are made payable to the SDIRA account. Similarly, any operating expenses must be paid out of the IRA.

When you purchase real estate using an IRA, it’s important to know that you will have a lot less leeway to use the property than if you bought the property with cash or traditional financing. You can’t use it as a home office, vacation home, a second home, or a place for your children to live. The reason for this is that IRA’s have a firm “no self-dealing” rule, which prohibits you from using an IRA asset in any way that benefits you personally. That includes borrowing money from your IRA, selling property to it, or you or your family spending the night in your property. 

The no self-dealing rule also bars even minimal first-hand involvement with your property. For example, if your property needed a minor repair, you may be tempted to fix it yourself. Unfortunately, the IRS considers this “furnishing services” to the IRA, which is strictly prohibited. The penalties for this are pretty steep. The entire IRA would be considered distributed to you, and therefore taxable, plus you’ll owe a penalty. Of course, this also means that you’ll need enough capital in your IRA to cover any repairs or other expenses your property incurs. To avoid violating the “self-dealing” rule, always keep in mind that your IRA owns and operates the property. So if you need to have work done on your property, your IRA must pay someone else to do it.

When your property generates rental income, all of that income goes straight back into your IRA. Because you do not personally own the property, you can’t access any of the income. Of course, you will eventually get the money when you make withdrawals from your account at retirement.

The Bottom Line

If you do decide to buy property using your IRA, you will have the advantage of collecting rent from your tenants and letting it grow tax-free in your IRA. Having said that, purchasing property through an IRA is an especially risky prospect. If you encounter significant repair or maintenance costs, you might need to make additional contributions to your IRA, which could also subject you to penalties for contributions that exceed the annual contribution limits. If you decide this is for you, make sure that you have a self-directed IRA custodian who is experienced with real estate transactions.

What to Know About Buying in Mexico

If you’re looking for property that’s close to the beach in a year-round warm climate, you’d probably have to pay heavily for that stateside. But south of the border, Mexico is home to a flourishing real estate market that is much more affordable and has successfully lured hundreds of thousands of expats. Whether you’re seeking a retirement home, a rental property, or a recurring winter getaway, Mexico has countless options for scenic places to live and is only a few hours away from the US by plane.

While figures vary, in 2019, the Mexican Institute of Statistics estimated that there were at least 799,000 American-born people living in Mexico and The U.S. Embassy in Mexico City put that number closer to 1.5 million. In San Miguel de Allende, ten percent of the city’s residents are originally from the United States. Despite a lot of negative publicity that Mexico has garnered in recent years, expats have found Mexico to be much safer in general than the news would indicate.

While it may seem complicated to buy property in Mexico, the real estate market is hospitable to foreigners, who are able to legally purchase, live in, rent, sell, and even bequeath their property to their heirs. There is a catch though: foreign ownership of Mexican property was outlawed in 1917 and remained prohibited until 1973, when the government passed the Foreign Investment Law. The law allows foreigners to acquire property in Mexico, as long as it is located outside of the so-called Restricted Zones, which includes any land within 100 kilometers of foreign borders or within 50 kilometers of the ocean. As a consequence, this law largely prevented development in those zones and was modified in 1993 by the Mexican government. Foreigners are now allowed to buy property in the restricted areas but only indirectly through a “fideicomiso,” which is a trust agreement between the buyer and a Mexican Trust Bank. Under this arrangement, the title to the property is held by an authorized Mexican financial institution.  As the beneficiary of that trust, your property cannot be sold or modified without your express written permission. Today, these trusts operate on 50-year terms, and are renewable and transferrable. It’s always a good idea to work with an experienced real estate company that is familiar with Mexican law so that you are protected with the most accurate and up-to-date information. 

Financing

Financing a property in Mexico is technically available to Americans, but not quite as accessible as it is for Mexican citizens. Case in point: only about five percent of the real estate transactions that take place in and around the Puerto Vallarta area have any kind of mortgage financing. Over the years, there has been a trickle of lending institutions aimed at international buyers, but none of them stuck around for long. There were multiple challenges for creating this type of financing infrastructure, including a lack of reliable credit reporting services and verifiable appraisals. The majority of buyers have found it much more efficient and much less expensive to arrange financing in their home country based on the assets they already have there.

The Once in a Lifetime Lumber Shortage

If you’ve looked into making any home improvements lately, you’re already well aware of the skyrocketing costs and delays involved in buying lumber. At the outset of the pandemic, the lumber and construction industries braced themselves for a slowdown, even closing some lumber mills. But the slowdown never came and now builders and lumber companies are seeing a once in a lifetime surge in demand

        The numbers reflect the trend: about 3 in 5 homeowners have made home improvements since March of last year. Home Depot saw a 20% increase in its sales in 2020. With that unprecedented demand, lumber prices skyrocketed. Previously, one thousand board feet of lumber had traded between $200 and $400. That price has now jumped to over $1,000. Whereas the wood for a new construction build a couple years ago would have averaged about $10,000, the new cost is $40,000. And that’s assuming you’d even be able to get your hands on it, with long wait times having become the norm. So with all that increased demand and an industry that can’t meet it, that must mean that people who want to remodel their homes just have to exercise some patience and hope that they’ll be able to move forward eventually, right?

Actually, it depends on what you’re building. If you’re interested in building a new deck, there’s an alternative manufacturer that’s been able to capture some of this unmet demand. Composite wood, a combination of actual wood chips and recycled plastic, saw its popularity explode in 2020. The composite wood company Trex is the leading manufacturer in this arena, capturing more than 50 percent of the market. While composite wood had been more expensive than traditional wood, the rising cost of lumber has put them each on a level playing field. With cost no longer an issue, and composites being more durable and resistant to weathering and damage than lumber, the only downside to using composites is that it’s mainly for outdoor use.

Over the past five years, Trex’s shares were already on fire, jumping from $11 to $97. That increase set a record for the 24th highest jump in the history of the S&P 1000. In 2020, Trex’s earnings increased by 18% to $881 million, followed in Q1 by a 23% year-over-year jump, and for Q2, CEO Bryan Fairbanks has stated that there will be a gain of 36%.

        Trex can expect their demand to continue. According to Dodge Data & Analytics, construction projects costing more than $50 million each will increase by at least 40% year-over-year, with multifamily builds constituting about 45% of these projects. Meanwhile, the real estate services and investment firm CBRE is seeing new development and permit authorizations in 2021 at a 10-year high, with no signs of a dropoff. With this forecast, the lumber shortage will likely persist, with alternative suppliers continuing to fill the demand.

All About Taxes

All About Taxes

As the year draws to a close, so does the deadline for many tax deductions. If you’re a real estate investor, these deductions may be more top of mind than most people. After all, one of the reasons that many people invest in real estate is not just to generate income, but also to receive some tax benefits.

To start, don’t try and save a few bucks and do your taxes on your own. If you’re an experienced real estate investor, you already know that real estate tax law is extraordinarily complex and if you’re new then take note. It will be well worth your time and money to hire a CPA to make sure you follow the best approach for your deductions and you take advantage of all of them.

Also, not every CPA is skilled in Real Estate or business deductions. You need to find someone who has many investor clients and knows and keeps up to date on all of the write offs you can take advantage of. All too often, I speak with an investor and even with a CPA they are missing out on major deductions. So when choosing a CPA, choose wisely and carefully.

Below I listed some Tax items you may be able to write off. I am not an accountant, but I work very closely with mine. So don’t take this as tax advice, but if there is anything your CPA is currently not writing off, you may want to ask them about it.

1. Depreciation

The way you depreciate an asset will differ depending on what the asset is. Different assets, such as a refrigerator or a building, will have different types of depreciation, such as straight line depreciation or accelerated depreciation. Consult your CPA to determine the type of depreciation to use and the life of each asset you are trying to depreciate.

2. Passive Activity Losses

Owning rental property is considered a passive activity. There are complex rules which apply to passive activities, but in short, they limit your ability to claim losses incurred in passive activity against other types of income.

3. Repairs

You may deduct the expense of repairs that have occurred in a given tax year. Repairs are considered work that is necessary to keep your property “in good working condition”. They do not add significant value to a property.

Improvements are seen as adding value to the property. Improvements cannot be deducted in full in the year they incurred. Rather they must be capitalized and depreciated over their life.

4. Travel Expenses

Landlords are allowed to deduct certain local and long distance travel expenses that are business related. Most people claim this in mileage.

5. Interest

You can deduct the interest you have paid on business-related expenses such as your mortgagee, car loan, and business credit cards.

6. Home Office

You can take the home office deduction if you use a part of your home exclusively as an office for your business. You must conduct the majority of your business here to claim the deduction. The amount you can deduct depends on the percentage of your home that your home office takes up.

7. Entertainment Costs

Entertainment costs mean those incurred during business dealings. For example, taking a client to your country club or giving a potential investor two tickets to the theater are entertainment expenses.

8. Legal and Professional Fees

If you hire a professional to do work for you, the fee you pay to them is deductible.

9. Employee Compensation

If you hire someone to do work for you, you can deduct the wages you pay to them as business expenses. This includes the wages of both full-time employees, such as a property manager or a live-in superintendent and part-time employees, such as a contractor you hire once to fix a roof leak.

10. Taxes

You can deduct your property taxes, real estate taxes, and sales tax on business-related items that are not considered depreciable for the year.

11. Insurance

You can deduct the premiums you paid on most types of insurance including health, accident, causality, theft, flood, fire, liability, vehicle, and health insurance for your employees.

12. Casualty Losses

If your property was damaged by a catastrophic event like a fire, you may be able to deduct some or all of the loss. The amount you can deduct will depend on your insurance and the amount of damage to the property.