Investing in alternatives in your IRA is a different process than if you were investing outside of an IRA. Some investors, not realizing the differences until it’s too late, have made mistakes that have forced them to lose the tax-advantaged status of the account, caused them to miss out on investments, or other avoidable consequences.
It doesn’t have to be that way: you have the benefit of learning from these past mistakes to successfully make your investment the first time. Here’s what you need to know.
1. Not having the right documents/right titling for a self-directed retirement plan
The first mistake we often see is clients not having the right documents in order, or not having those documents titled in the name of the Equity Trust self-directed retirement plan.
For example, when you enter into a purchase contract where you’re buying a property with your IRA, it’s important that the purchase contract lists the buyer as your IRA – not you personally, not your LLC, but your IRA.
We’ve seen clients in the past try to put a property under a contract personally and then assign the contract to their IRA, which can be considered a prohibited transaction. Your IRA would essentially be distributed on January 1 in the year in which that transaction occurred.
Make sure that from the very beginning, the contract is titled properly. Even if you could amend the contract, or draft a new contract, that amounts to extra work, time, energy, effort, and, of course, money to prepare the documentation. So make sure you get this right from the very beginning.
What does this look like? When you title a property contract or any other investment documentation for your self-directed IRA, it would read:
Equity Trust Company Custodian, FBO (for benefit of) [your name] IRA
If you’re using a Roth IRA, you would swap “IRA” for “Roth IRA.” If it’s a health savings account or Coverdell Education Savings Account, you would plug and play the applicable account. If you’re using a solo 401(k), there’s a little bit different naming convention. Ultimately when you get to that point, Equity Trust can walk you through the specific titling.
Another example: If you’re buying notes or originating loans, being a private lender, a hard money lender using a self-directed IRA, the lender on the promissory note and mortgage must be in the name of the IRA.
Sometimes, investors at the 11th hour need to fund their transaction and they send their documentation into Equity Trust without proper titling. That’s not acceptable and can put you at an extraordinary amount of financial risk of not being able to process a transaction, as well as the risks associated with the tax efficiency of the IRA.
Also, if you’re investing in a private entity like an LLC or corporation that’s privately held, usually you need to fill out what’s called a subscription agreement. Under that subscription agreement, the subscriber is your IRA. So you use that same titling. There again, all too often we see investors make the mistake of not properly titling that investment documentation.
2. Trying to obtain standard bank financing for a real estate property purchase in an IRA
Some self-directed investors who want to buy a property think, “I’ll just go down to my local bank, and my banker or mortgage broker whom I typically work with will give me a loan to buy this property with my IRA.”
Other investors may think: “Well, I’m just going to use my IRA as a down payment and then get a bank loan.” You may be able to do that. But you have to borrow the money on what’s called a non-recourse basis.
Your IRA cannot take on conventional financing because your bank or mortgage broker is going to require what’s called a personal guarantee that you personally sign. Under the provisions of Internal Revenue Code 4975, you personally cannot guarantee that debt. So you have to make sure if you’re going to borrow money to buy real estate, that you obtain a non-recourse loan.
Video: 3 Self-Directed IRA Mistakes
3. Waiting too long to fund your self-directed IRA or 401(k)
All too often, investors fail to establish and fund their account well in advance of making an investment. They call us two to four days before they need to close on a deal to open and fund their self-directed IRA with an existing retirement account.
Why is this a problem? First, if they are in a stock market position – that could be individual stocks, ETFs, or mutual funds – it’s going to be between one to three days to settle those assets and liquidate those positions in order to transfer those over to an Equity Trust self-directed IRA.
Additionally, it is not an overnight process to move your funds from one financial institution to another. You are at the mercy of that other financial institution.
And all too often, folks wait until the 11th hour. And then they go through the pain and suffering of being worried about not meeting their closing deadlines or having to negotiate with the seller to extend the closing date, or even worse, missing out on the transaction altogether. We see this happen time and time again
It’s not always easy to hear that mistakes can be made, but it’s important to learn so they’re not repeated. We take great pride and great passion in setting you up for success on your next real estate or other alternative investment transaction.
Do you still have questions about the self-directed investing process? Start a conversation with a knowledgeable IRA counselor. Please tell them you were referred by Boston Real Estate Investors Association and get discounts on your setup fee along with priority service.