The Problem – For years I have wrestled with the idea of retiring overseas. Well, to be honest, I probably will never fully retire, or move permanently out of the United States. Yet as I travel across multiple countries, the concept of immersing myself, my wife and my family in a new culture is becoming more intriguing. Turns out I am not alone. According to the Association of Americans Resident Overseas, over 8 million US citizens reside outside the US.
This dream however, for most – will never come true. The financial resources to purchase the second home outside the country may not be within the reach of most buyers. Financing for these projects or homes outside the US is often unavailable or expensive, eliminating the cash-flow advantages of purchase. After the thrill of experiencing paradise for a week, the visitor returns home, speaks to his CPA, and determines that the aspiration of foreign investment is not feasible.
Yet, many of us may have the means to purchase investment property right under our nose – in an IRA. Better yet, in a Roth IRA. Once you learn the rules, you may be surprised on how easy it is to invest in the very country and community you wish to retire, years before you actually want to move in.
All IRAs are eligible to purchase real estate for investment purposes. Traditional, SEP, Simple, and Roth IRAs can easily acquire property, whether purchased directly with Fee Simple Titling, or through an LLC or other corporate structure. This opportunity is not limited to property within the US.
As a reminder, the Traditional, SEP and Simple IRAs are all pre-tax accounts, meaning that the contributions into the account and the growth are generally not subjected to income tax until the funds are distributed or withdrawn. The Roth IRA contributions are taxed before they are placed into the account, like all other IRAs, the investment growth is not taxed in most cases, and when distributed, all the distributions are tax free.
Unfortunately, IRS rules dictate that any asset held in an IRA cannot benefit the account-holder or certain family members. In the case of real estate, it means that these individuals are disqualified people, and thus cannot stay in their IRA owned rental property.
How does this work in a practical sense and why is a Roth IRA the preferred account to use? Here is an example:
John and Sue have several friends who have retired on a part-time basis to Mexico and Nicaragua, and they have always been intrigued by the lifestyle that their friends proudly post on their Facebook page. They attend an expo in their city about living and investing abroad, and receive an invitation to visit Belize. Based on their love of fishing, boating and diving, they purchased tickets and spent five unforgettable days in the sun and azure sea.
After learning about a new development that is breaking ground on an island off the Belize mainland, they return home and start plotting on how they can purchase now, while it is still affordable, as they are concerned about pricing increased based on future demand. Although they are both 50 years of age, John calculates that they will be able to afford to retire by age 60. They would like to personally use their purchased coastal condo for three-months per year during their retirement.
Sue hears about self-directed IRAs and learns that she and her husband may be able to use a 401K rollover or IRA to purchase investment real estate. There is only one wrinkle; if the pre-tax IRA buys the rental property now, any growth in asset value and the rental income will be taxed upon distribution. If Sue and John want to use their IRA-owned property personally, they will need to have it distributed to them, which would subject them to ordinary income tax on the appraised value of the house. If the property doubles in value over 10 years, the taxable income would also double.
If John and Sue had decided to convert their traditional IRA to Roth before they purchased their rental, they would never need to pay taxes again. The requirement would be that they would have to have their Roth IRA funded for at least 5 years, and have reached the age of 59.5 years before they could take a tax-free distribution.
So, if they invested $200,000 in the condo with their Roth IRAs, over the next ten years, all the rental revenues would roll into the IRA account. Ten years later, the property is now worth $400,000, with cash from rentals well over $100,000. Should they wish to live in the property, they can take distribution of property without taxation simply through changing the titling. The Cash balance in their Roth account is also available for additional tax-free investing or simply used for future distributions.
In simple terms, a Roth IRA allows John and Sue to pay taxes on the “seed-money” of the investment, rather than the earnings and growth of equity. If they are in the top federal tax bracket both when they purchase the investment and when they take the property as distribution – using a Roth for the purchase would save John and Sue over $118,000 in taxes ( $79,200 in Roth vs $198,000 in Traditional IRA).
If non-recourse financing is available, the IRA accounts may also be able to purchase the condo with just a down-payment, and the rental proceeds could pay off the loan over time. This possibility is available within any type of IRA.
Self-Directed IRAs may also be used to purchase land or lots, either for future building, or simply for appreciation.
While your CPA or financial advisor may not know or understand the possibilities of a self-directed IRA, at NuView we have 14 years and thousands of client who access their IRA to purchase investment real estate. Just fill out the form on the right, and we will be happy to step you through the very easy process, most of which can be accomplished online.