Investors buying real estate with retirement money

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Tim Beeson has been investing his retirement savings in real estate for almost two decades, and he has noticed he’s not alone anymore.

More people are turning to real estate to grow their fortunes.

At least three investors bought more than half a dozen properties at the El Paso County Public Trustee’s foreclosure auction this year using their IRAs. While that might not sound like a lot, it’s a lot more than Beeson has seen in previous years when he was the only one bidding with IRA money.

Area investment advisers and accountants say they’ve been fielding more questions from clients about buying real property with their retirement savings. And it’s a tricky topic for most of them.

“Most investment advisers want to keep an arm’s length from that kind of thing,” said Tim Watson, a certified financial planner with Strategic Financial Partners.

He can help clients who want to buy stock in real estate investment trusts, but he has to turn them away if they’re looking to fix and flip houses or buy up rental properties within their accounts.

The problem, he said, is that those kinds of holdings aren’t liquid. So if an investment starts to head south, the client can’t snap his fingers and say “sell.”

It takes time to get out of a real estate investment, which puts financial advisers and account managers in a precarious place.

There’s only one bank in town that handles the kinds of IRA accounts that allow holders to invest in real property — Integrity Bank and Trust, which serves as a custodian for self-directed IRAs.

“We limit our liability,” said Larry Dozier, an advisor at Integrity. “The client takes on the responsibility for their IRA and we have a disclosure saying we’re not liable.”

That allows people more freedom to make less-liquid investments with their retirement money while still sheltering it from taxes.

“It’s become very popular in the last three years,” Dozier said. “I know my business has grown dramatically the last three years with self-directed IRAs.”

How self-directed IRAs work

To start a self-directed IRA, a client needs to liquidate his or her existing IRA or Roth IRA and transfer it to a custodian, like Integrity, that will allow self-directed investment.

Beeson always had a house to fix up and sell when he was younger and working full time. There came a time when he found a place he wanted to buy and didn’t have the cash.

“But I had all this money in my IRA,” he said.

He started looking around for a bank that would let him make hard investments with his IRA. He found Mid Ohio Securities, which is now The Equity Trust Co. It was the only bank he could find at the time and it was the only one doing it for a long time, Beeson said.

Now there are several.

The custodian handles all of the transactions so the account owner can keep his hands out of it, Dozier said.

“We get all the bills,” he said. “They all come to us. Everything goes through us.”

When Beeson buys a property in his IRA, he has to stay out of it. Nothing is in his name. It’s always the trust. He has to hire a contractor to work on the houses. He can’t do it himself. And if he ends up buying a rental property, a property manager has to take care of it, Beeson said.

Other ways to invest

Karen McClaflin has been fixing and flipping houses since 1996. She bought the We Buy Ugly Houses franchise in 2006 and let it lapse to found Home Source Partners in 2009. She worked with clients, investing their money and turning properties around quickly.

She had a client and friend who had been investing with money from her personal accounts. When she wanted to get in on a larger project, she told McClaflin she could probably figure out how to use some of her retirement money since she already had it at Integrity in a self-directed IRA.

Things went so well that it caught Dozier’s attention and he asked two years ago if his other clients could invest with Home Source.

McClaflin writes promissory notes on specific properties. They’re usually 90-day notes paying about 12 percent interest and Dozier asks his investors who wants in.

“This is a way for people at all different levels in their retirement savings to participate in real estate investment,” McClaflin said. “It allows clients to have diversification in their retirement accounts.”

If someone has $100,000 in a self-directed IRA it might not be enough for them to pay cash for an $80,000 property, make repairs and resell — at least not comfortably.

McClaflin offers a high rate of return over a fixed term.

She keeps the money moving. Only occasionally she writes a one-year promissory note and uses client money to make multiple investments. Otherwise, McClaflin makes a point to take possession of a house, remodel it to neighborhood standards and resell it within 90 days. If it goes more than 120 days, she converts it to a rental property and refinances, she said.

“In the end I just write one check to Integrity and there might be four underlying clients,” she said.

It’s simple and clean and doesn’t blur the lines between acceptable and unacceptable behavior in a tax sheltered account.

Risks

Of course, the reason the returns are high is that the risks are, too.

If McClaflin begins failing on multiple investments it could spell disaster not just for her and her business, but also for her investors.

The recourse for the investors would be the same recourse a bank has — foreclosure, Dozier said.

There are a lot of risks involved in self-directed IRAs and real estate investing. For someone who invests outright in a property, there needs to be a healthy buffer where the account can afford to continue making payments if a property doesn’t sell, Dozier said.

“You can see some substantial gains,” said Jackie Spegele, CPA and owner of Numeric Strategies. “But when it goes bad, it can be really bad.”

The problem is that it’s hard to get out of a bad property investment, she said.

“Your exit strategy is not very good,” Spegele said.

Beyond that, there are a lot of places where self-directed IRAs can get caught up in issues with the IRS.

Beeson uses traditional IRA money that wasn’t taxed when it when it went into the account and Roth IRA money that was taxed when it went in, but won’t be when it comes out.

Taxes are the reason everyone is so cautious about self-directed IRAs. There can’t be any indication that the owner is doing anything with the money directly. It’s an investment, never a business, Beeson said.

If the fund owner gets tangled up in it in anyway, the IRS can disallow the entire account and charge a penalty.

“The penalties are extreme,” he said.