IRA, 1031, 401k Invest

Everbody seems to know about IRC 1031 exchange. But buying property as an IRA or 401k?  The government has made allowances for investors to use these investment tools as well.

 1031 Exchange:

Thanks to IRC §1031, a properly structured exchange allows an investor to sell a property, to reinvest the proceeds in a new property and to defer all capital gain taxes. IRC §1031 (a)(1) states:

"No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment, if such property is exchanged solely for property of like-kind which is to be held either for productive use in a trade or business or for investment."

To understand the powerful protection an exchange offers, consider the following example:

• An investor has a $200,000 capital gain and incurs a tax liability of approximately $70,000 in combined taxes (depreciation recapture, federal and state capital gain taxes) when the property is sold. Only $130,000 remains to reinvest in another property.
  
• Assuming a 25% down payment and a 75% loan-to-value ratio, the seller would only be able to purchase a $520,000 new property.
  
• If the same investor chose to exchange, however, he or she would be able to reinvest the entire $200,000 of equity in the purchase of $800,000 in real estate, assuming the same down payment and loan-to-value ratios.

As the above example demonstrates, exchanges protect investors from capital gain taxes as well as facilitating significant portfolio growth and increased return on investment. In order to access the full potential of these benefits, it is crucial to have a comprehensive knowledge of the exchange process and the IRC. For instance, an accurate understanding of the key term like-kind - often mistakenly thought to mean the same exact types of property - can reveal possibilities that might have been dismissed or overlooked.

401k-IRA Investing:       Note: I highly recommend this site. I worked on an IRA deal in dollar point with my father-in-law and he is using equity trust  http://www.trustetc.com/index.html

Here’s a simple wealth strategy you can easily implement by using your IRA or 401K and real estate investing.

Step One- Roll your funds into a self-directed IRA (Individual Retirement Account)

The first thing you need to do in order to combine your IRA or 401K and real estate investing is to roll your available funds over into a self-directed IRA. This is nothing more than a regular IRA account administrated by a company that allows you to determine specifically how and where the money is invested.

A Self-directed IRA, also known as a Checkbook IRA, allows your funds to be placed into a checking account, giving you far more flexibility and “liquidity” than with typical retirement accounts. You can then use the funds by simply writing a check, combining your IRA or 401K and real estate investing.

There are several sources and providers of self directed IRA accounts. Use online search resources for assistance in locating them. One such company, highly respected for combining your IRA 401K and real estate investing, is Equity Trust Company.

Step Two- Determine your investing criteria

Before you start using your IRA or 401K and real estate investing together, it’s important to think through your investing criteria. What kind of real estate investor do you want to be? Do you have the temperament and financial resources to hold and rent property, or are you better suited to quick-turn real estate? Does rehabbing suit you, or are pretty houses more in keeping with your skills and abilities?

These are vitally important questions, and the time to ask and answer them is before you start using your IRA or 401K and real estate investing.

There are lots of online resources for helping you make these kinds of decisions. I’ve written another article that can help you determine which type of investing is right for you. You can find it at Best Income Opportunities.

Once you’ve determined the type of investing you’re suited for, you’ll know what types of properties fit that criteria, and you’ll be ready to start using your IRA or 401K and real estate investing.

Step Three- Locate a property that fits your investing criteria

Now is the time to hunt for properties that fit the investing criteria you’ve established for yourself. When you’re just beginning real estate investing. I would stick to single family homes and small multi-units (1-5 units). Leave the larger apartments and commercial properties until after you’ve gotten your feet wet in IRA / 401K and real estate investing.

Find and work with a good Realtor who can help you locate properties that work for you. Look for value in your real estate investing… in other words, buy for well under retail. Buying value is the secret to success in this business, and builds instant equity.

Step Four – Let your Account Administrator walk you through the first few transactions

The companies that administrate self directed IRA accounts know their business well. They have a vested interest in helping you succeed with IRA or 401k and real estate investing. Make use of their expertise and let them hold your hand through the first few purchases you make. They will help you avoid landmines you would never see otherwise.

You will need to follow the specific rules for IRA or 401K and real estate investing, and one of those rule is that all monies paid related to your property must come from the self-directed account. That means that every expense, no matter how small, must be written out of your self-directed IRA checkbook. Also, the property must be bought, sold, and held under the self-directed IRA.

You can see from these two examples that the rules can be complicated, although not so complicated that you should let it stop you from investigating this exciting and lucrative investing niche. After all, by combining your IRA or 401K and real estate investing, you can watch your nest egg grow exponentially, while avoiding the tax man’s big bite.

That’s it… four simple steps to building wealth using the incredibly powerful combination of your IRA or 401K and real estate investing. As it says on the shampoo bottle in your tub… lather, rinse, repeat!

Now, go make more offers!

When you purchase property and rent it out, you're essentially running a business. You take in revenue — namely rent from your tenants — and incur expenses from the property. You hope that, over time, your revenue exceeds your expenses so that your real estate investment produces a profit (cash flow, in real estate lingo) for all the money and time you've sunk into it. You also hope that the market value of your investment property appreciates over time. The IRS helps you make a buck or two through a number of tax benefits. The major benefits follow.

Operating-expense write-offs

In addition to the deductions allowed for mortgage interest and property taxes, just as on a home in which you live, you can deduct on your tax return a variety of other expenses for rental property. Almost all these deductions come from money that you spend on the property, such as money for insurance, maintenance, repairs, and food for the Doberman you keep around to intimidate those tenants whose rent checks always are "in the mail."

But one expense — depreciation — doesn't involve your spending money. Depreciation is an accounting deduction that the IRS allows you to take for the overall wear and tear on your building. The idea behind this deduction is that, over time, your building will deteriorate and need upgrading, rebuilding, and so on. The IRS tables now say that for residential property, you can depreciate over 27-1/2 years, and for nonresidential property, 39 years. Only the portion of a property's value that is attributable to the building(s) — and not the land — can be depreciated.

For example, suppose that you bought a residential rental property for $300,000 and the land is deemed to be worth $100,000. Thus the building is worth $200,000. If you can depreciate your $200,000 building over 27-1/2 years, that works out to a $7,272 annual depreciation deduction.

If your rental property shows a loss for the year (when you figure your property's income and expenses), you may be able to deduct this loss on your tax return. If your adjusted gross income is less than $100,000 and you actively participate in managing the property, you're allowed to deduct your losses on operating rental real estate — up to $25,000 per year. Limited partnerships and properties in which you own less than 10 percent are excluded.

To deduct a loss on your tax return, you must actively participate in the management of the property. This rule doesn't necessarily mean that you perform the day-to-day management of the property. In fact, you can hire a property manager and still actively participate by doing such simple things as approving the terms of the lease contracts, tenants, and expenditures for maintenance and improvements on the building.

If you make more than $100,000 per year, you start to lose these write-offs. At an income of $150,000 or more, you can't deduct rental real estate losses from your other income. People in the real estate business (for example, agents and developers) who work more than 750 hours per year in the industry may not be subject to these rules.

You start to lose the deductibility of rental property losses above the $100,000 limit, whether you're single or married filing jointly. You can carry the loss forward to future tax years and take the loss then, if eligible. This policy is a bit unfair to couples, because it's easier for them to break $100,000 with two incomes than for a single person with one income. Sorry — this is yet another part of the marriage tax penalties!

Rollover of capital gains on rental or business real estate

Suppose that you purchase a rental property and nurture it over the years. You find good tenants and keep the building repaired and looking sharp. You may just find that all that work pays off — the property may someday be worth much more than you originally paid for it.

However, if you simply sell the property, you owe taxes on your gain or profit. Even worse is the way the government defines your gain. If you bought the property for $100,000 and sell it for $150,000, you not only owe tax on that difference, but you also owe tax on an additional amount, depending on the property's depreciation. The amount of depreciation that you deducted on your tax returns reduces the original $100,000 purchase price, making the taxable difference that much larger. For example, if you deducted $25,000 for depreciation over the years that you owned the property, you owe tax on the difference between the sale price of $150,000 and $75,000 ($100,000 purchase price minus $25,000 depreciation).

All this tax may just motivate you to hold on to your property. But you can avoid paying tax on your profit when you sell a rental property by "exchanging" it for a similar or like-kind property, thereby rolling over your gain. The section of the tax code that allows rollovers is a 1031 exchange. (You may not receive the proceeds — they must go into an escrow account.) The rules, however, are different for rolling over profits (called 1031 exchanges, for the section of the tax code that allows them) from the sale of rental property than the old rules for a primary residence.

Under current tax laws, the IRS continues to take a broad definition of what like-kind property is. For example, you can exchange undeveloped land for a multiunit rental building.

The rules for properly doing a 1031 exchange are complex. Third parties are usually involved. Make sure that you find an attorney and/or tax advisor who is expert at these transactions to ensure that you do it right.

Real estate corporations

When you invest in and manage real estate with at least one other partner, you can set up a company through which you own the property. The main reason you may want to consider this setup is liability protection. A corporation can reduce the chances of lenders or tenants suing you.

Tax credits for low-income housing and old buildings

The IRS grants you special tax credits when you invest in low-income housing or particularly old commercial buildings. The credits represent a direct reduction in your tax bill because you're spending to rehabilitate and improve these properties. The IRS wants to encourage investors to invest in and fix up old or rundown buildings that likely would continue to deteriorate otherwise.

The amounts of the credits range from as little as 10 percent of the expenditures to as much as 90 percent, depending on the property type. The IRS has strict rules governing what types of properties qualify. Tax credits may be earned for rehabilitating nonresidential buildings built in 1935 or before. "Certified historic structures," both residential and nonresidential, also qualify for tax credits. See IRS instructions for Form 3468 to find out more about these credits.

Quoted from Investing for Dummies-I recommend this book!

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