David Moore with IRA Advantage takes a close look at real estate self-directed IRAs. He examines what you can and can’t invest in with a self-directed IRA, and he provides insight into prohibited transactions. Empower yourself by understanding the range of investment options.
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What Can’t You Invest in with a Self-Directed IRA?
The easiest way to explain what you can invest in is to say what you can’t invest in. By law, an IRA can legally invest in anything other than collectibles, life insurance contracts or stock in a Sub S Corporation. The way the law works, if it’s not specifically prohibited, it is allowed. If you’ve heard our story, you know that we got into this business because our 1031 clients wanted to take their retirement accounts and go buy real estate. Our intent when we got involved with this business was to give people more opportunities to spend money in real estate and take advantage of buying things that are not tied into Wall Street.
Typically, people come to us when they want to buy real estate, make loans, or buy notes. We also do a lot of what’s called rollover business start-ups where we can literally create a business that you’re employed by. So there is quite a variety of things you can do. A 401(k) plan is actually even less restrictive than IRAs. With a 401(k) plan, the only investment you cannot make is in collectibles. So once again, if it’s not specifically prohibited, it’s allowed. Real estate, for most of our clients, is not prohibited, therefore it’s allowed. One thing that is prohibited is buying the property to occupy with their business, and that constitutes a prohibited use. The investment in the building is not the problem; the problem is the use of that building.
When I look at a 1031 exchange, for example, I look at it for four basic cornerstones. It’s got to be an exchange. What’s given and received have to be of like kind. We satisfy what we call the napkin test, which means you’re going across or up in value and equity. You’re going to hear lots of people talk about having to replace debt in an exchange. That is totally wrong. Debt does not have to be replaced. You can have a reduction in debt in two ways. One is by going down in value, which triggers a problem because you went down in value. The other way debt goes away is by adding cash.
If you look back during the crash, what happened to a lot of people’s loans during that period of time was a reduction in loan to value. You had to add principle. On top of that, a lot of people had a reduction in equity—the properties went down. So we had situations where people couldn’t even get financed sometimes. They’d have to buy a property outright. They’d come in and ask, “Hey, do I have to pay off this property, predisposition, because I don’t want to get debt on the replacement.” Those are my four cornerstones on 1031.
If we’re looking at IRAs or 401K plans, I look at two issues. What a person wants to buy and who they are transacting between or for the benefit of. As I already explained, rarely is the investment our problem. What typically is going to cause an issue is a transaction between or for the benefit of that disqualified party. So once again, back to the business property. You want to buy the building that your business is going to occupy; you can’t because it’s a prohibited transaction between disqualified parties.
Or suppose you want to buy Johnny an apartment at school. You can’t do that because your child is a disqualified party to your plan. Or if you want to buy that place at the beach and you want to go use it, that’s not okay. You want to work on the property, it’s a prohibited transaction; sweat equity is not okay in those situations.
To repeat, you can literally invest in anything other than collectibles, life insurance contracts, and stock in a Sub S with an IRA. With 401k plans, the only restriction is collectibles.
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