My success investing my SEP-IRA retirement money in the stock market has so far only met limited success.  For one I am not very skilled at betting on the right horses and in part this success has been limited by fees from investment brokerages.  I have been looking for alternatives to invest my retirement funds in to create better, more consistent results for my portfolio.  One day I attended an in-house office meeting and listened to a presentation of a local attorney that assists clients in setting up Self-Directed IRAs.

A self-directed IRA is a lesser known of our IRA options.  It requires account owners to make active investments on behalf of the plan. To open one, an owner must hire a trustee or custodian to hold the IRA assets and be responsible for administering the account and filing required documents with the IRS.

Similar to other IRA accounts, owners can invest in stocks, bonds and mutual funds, but they can also invest in real estate and small businesses. You are not allowed to personally benefit from the asset outside the tax deferred income into the IRA.  For example, one cannot purchase real estate in a self-directed IRA and use it as a second home, buy a vacation rental property and ever use it yourself or purchase a boat slip for your boat.

The process of using a self-directed IRA to jump into investing in real estate requires preparation and a little caution.  Investors are recommended to seek legal advice from an attorney who is experienced in this field, as well as seek input from an accountant and a real estate agent. It is also recommended they become familiar with the rules for the type of IRA theyre using. Whether it is a Simple IRA, Roth or Traditional IRA, SEP or Solo 401(k), contribution limits apply and just like more conventional IRAs, there are penalties for early withdrawals.

Over the years I have heard many real estate brokers talk about Self directed IRAs, but I never seemed to meet a broker that had done a transaction like this nor one that had invested in this themselves.  I became more and more fascinated with this type of investment and noticed that my IRA account balance was still not going up much while the stock market was supposed to be recovering.  Being self-employed I have been able to contribute to a SEP IRA.  Each year I have maximized my contribution and because of this I accumulated a sizable portfolio, substantial enough to purchase 1-2 modest properties with it. I decided to dig out the business card of the attorney who presented at our office and call him to discuss such an investment in detail.

After a brief consultation, this attorney assisted me in creating an LLC which contains the IRA assets and helped me hire a custodian / trustee that holds the IRA assets.  Once the LLC was formed, I opened a bank account in the LLCs name and then transferred the funds I was going to invest from my IRA to the custodian / trustee who then subsequently transferred those funds to the LLCs bank account.  From there I was able to purchase a property with funds in the LLCs bank account.  Be careful at this point not to commingle any personal funds with funds from your IRA as a large income tax bill and penalties may follow.

I also learned that I did not want to invest my entire portfolio into real estate for several reasons.  I was concerned that if I would ever come to pass, my heirs would have to pay personal income tax over the amount and so it would be prudent to keep sufficient funds more liquid so this can be taken care of.  The other reason has to do with how an IRA will be distributed over time once I reach the age I have to draw from these funds.  Taking this into consideration, I decided to keep around 50% in my SEP IRA and I planned to use the other 50% to purchase a property.

I have since purchased this property and was able to rent it from 3 days after it closed.  I am very pleased with the results because:

1) Any income from rent is tax deferred.  I ended up purchasing a condominium in Belltown, Seattle as I really believe in the building as well as the location.  After paying property taxes and HODs, I have a 4.3% annual ROI not taking into consideration any appreciation on the property value.

2) if I estimate a very conservative average of 4% appreciation over time, I come up with a very desirable return on my investment of 8.3% with very minimal expenses.  I anticipate the results will be better, but of course, results will vary and any investment brings also along risks of losses.

3) all income tax on my rental profits are deferred to a time when I anticipate to have less income.  I hope to be taxed at a lower tax rate at that time.

4) I like owning real estate, especially when it is free and clear of a mortgage.  This asset will be appreciating another 20 years or so before I will need to liquidate it and draw from those funds.  In the mean time it will provide a very steady income stream into my retirement account.  I also anticipate that the value of the asset will have close to tripled by that time as property values on average in this area tend to double every 10 years or so.

If you are also interested and would like to have a discussion about making such an investment, please contact me.  It will be a pleasure to answer any questions you may have and to assist you in making such an investment.

Enrico Pozzo, Realogics Sothebys International Realty

Click here  to see a Wikipedia definition of a Self Directed IRA