Is commercial real estate part of your IRA?

People often tell me that they would love to invest in commercial real estate, but that they just don’t have the money. Did you know that you can invest your retirement funds in commercial real estate? Whether you’re a seasoned investor or just starting out, you can diversify the types of assets in your retirement fund by adding real estate to the traditional mix of investments, or you can invest in commercial real estate only.

The first step is to open a self-directed IRA. This is simply an IRA in which you, the client, choose your investments. You will also need to open the account with a custodian that allows alternative investments, has the background and experience to administer such accounts and provides you with all of the information and services you will need. It’s important to note here that custodians are not allowed to offer advice, but they can provide information and a list of qualified tax, legal and financial professionals, including commercial real estate brokers, who can provide such advice.

Custodians must be approved and regulated by the IRS, or affiliated with a regulated bank or trust company. Your lawyer, accountant or commercial real estate broker can probably refer you to one.

Congress recently established a Solo 401(k) that has numerous advantages for self-employed persons. This, too, can allow you to invest in commercial real estate. All of the existing rules for contributions and withdrawals apply to these accounts when they invest in commercial real estate. (Also keep in mind that many custodians will allow you to continue to invest in traditional investments along with alternative investments. This enables you to achieve diversification of your assets.)

The next step is to consider what kind of real estate to buy. There is really no limitation here, as long as the property is acquired strictly for investment, and not personal use. Qualified investments include raw land, single family homes, multi-family properties, rental properties of any kind, shopping plazas, office buildings, self-storage facilities, mobile home parks, condos, etc.

Keep in mind that all of the expenses related to the investment must be paid from the IRA and not the account holder’s personal funds, and that all income must go directly to the IRA. Failure to abide by this rule can result in disqualification of the transaction, and significant penalties.

The next consideration is whether to use financing. When you acquire commercial real estate with an IRA, there can be financing, as long as it is “non-recourse.” This simply means that if there is a default, the noteholder can collect only against the property, not the maker of the note. While most conventional lenders do not offer such financing, a number of lenders are familiar with IRA investing and offer such loans. A seller also can “take back” a mortgage – again, as long as there is no recourse to the maker of the note.

As with any type of investing, there are traps to watch out for when using your self-directed IRA. The most common are prohibited transactions and disqualified persons:

• You cannot buy from or sell to a prohibited person, including yourself, your spouse, a lineal ascendant or descendant, the spouses of descendants, or the fiduciary. (For some reason, siblings are not on this list of disqualified persons.)

• You cannot make personal use of the property. This means you can’t personally use a vacation home or perform maintenance on the asset. You also can’t, for example, hunt on raw land or dock your boat at an IRA-owned boat slip.

• You cannot use your IRA as collateral for a personal loan.

Why use a self-directed IRA to invest in commercial real estate?

• You can achieve greater diversification than with traditional IRA accounts.

• You earn tax-deferred compound growth.

• You have the ability to invest in what you know – many people understand how real estate works, and prefer it to the stock market.

• Tax-free investing and savings for life — if you use a Roth IRA to invest in commercial real estate, it is possible to realize income and appreciation entirely tax-free.

A number of commercial real estate investors both own and lend on investment properties and like to buy existing notes and mortgages related to investment real estate. Self-directed IRAs can be used for those purposes as well.

There are pitfalls in the process, and professional assistance is important to success, but the benefits of investing in commercial real estate can be enhanced by using a self-directed IRA.

Dan Scanlon is an investment broker with Grubb & Ellis/Coldstream Real Estate Advisors Inc., Bedford. He can be reached at 623-0100 or dscanlon@coldstreamre.com. PENSCO Trust, a self-directed IRA custodian, assisted in the preparation of this article.