Short-term Vacation Rental Properties

There are thousands of places you can invest your pre-tax (and Roth type) retirement savings – from bank CDs and mutual funds to stock/bond-managed portfolios and insurance company annuities. These accounts are typically managed by someone else; you can select the asset class but not the actual holdings, and you only get an annual or quarterly account statement. With trillions of dollars in these accounts, they are obviously popular, but there are alternatives – and diversification is key to successful investing!

You’ve probably seen some of these “alternative” investments advertised on TV, including precious metals, REITs (real estate investment trusts), and oil and gas. What do all these alternative IRA holdings have in common? They must be held and maintained in a self-directed IRA.

Did you know the money in your existing tax-advantaged retirement accounts may be used to purchase short-term vacation rental properties?

What is a self-directed IRA?

Self-direction refers to the client/investor making all his or her own investment decisions and then directing a trust/administrator to invest in the many traditional and non-traditional assets that the IRS allows in these types of retirement plans. These 3^rd-party trusts/administrators process transactions and make sure that the investment, investment structure, and titling comply with IRS code.

Investing in Real Estate Using a Self-Directed IRA

Investing in real estate using self-directed IRAs makes up the most popular asset class to be included in self-directed retirement plans? In fact, about half of all self-directed investments today are in commercial and residential real estate.

By investing in real estate using self-directed IRAs, you free up your discretionary, non-retirement savings and income for other expenses while building a more diversified retirement portfolio. These nontraditional assets are bought, owned, and sold by the IRA, which shelters your capital gains and allows the retirement account to earn tax-free or tax-deferred income (depending on whether you open a Roth or traditional IRA). You may also open a self-directed 401(k) or tap into a previous employer 401(k) for investing in real estate using a self-directed IRA if your employer’s plan allows for self-directed options.

Allowable real estate investments in self-directed IRAs include:

• Rental property – multi-family homes, condos
• Vacation rental homes — domestic and foreign properties
• Rehabs & foreclosures
• Undeveloped land & farmland
• Mobile homes
• Warehouses
• Lease options

Things NOT allowed by owners (or any disqualified person):

• Living on – or using at any time – the property
• Leasing the property for any business you own
• Doing repairs or rehab to the property
• Doing repairs or rehab to the property through any business you own
• If you finance the property: Personally guaranteeing the loan (must be a non-recourse loan)
• Paying expenses relating to the property with personal funds
• If you are a real estate agent or broker: Listing the property for sale or making commission on sale or purchase

*All income & expenses must flow through the IRA.

Should I invest in real estate using self-directed IRAs?

If you are already investing in real estate outside of your existing retirement account, or you know and understand the real estate market, investing in real estate using self-directed IRAs could be a great way to build a solid foundation for your retirement years.

FIRST, research and be familiar with:

• Different types of tax-advantaged accounts
• Where your retirements funds are located
• What type of accounts you have
• How self-directed transactions work
• How your retirement account accepts returns/dividends from investments

Types of Tax-Advantaged Accounts:

• Individual IRAs (Roth and traditional)
• SEPs and CODA SEPS
• 401(k) (Roth and traditional)
• 403(b) TSAs (typically offered to school employees)
• 457 Deferred Compensation Plans (typically offered to municipal employees)
• Some Health Savings Accounts (HSAs)

Most people who have such savings own an IRA, 401(k), or a combination of the 2. For the purposes of this paper, we’ll refer to those 2 options. IF you have questions about the others, please call me! Your tax or financial advisor is the best person to consult about your contribution eligibility and which type of retirement plan is best for you.

Retirement Fund Locations:

• Bank
• Insurance Company
• Trust Company
• RIA (Registered Investment Advisory Firm Custodian)
• Broker Dealer Custodian

These are your typical fund custodians. If your IRA/401(k) is held elsewhere, please call me for more information.

Account Types:

• Stock/Bond Managed Portfolios
• Insurance Carrier Annuities (fixed or variable)
• Bank CDs
• Mutual Funds

These holdings maintain over 70% of ALL retirement savings in America.

How do self-directed transactions work?

1. Open an account with an administration/trust company that specializes in these IRA transactions. Your self-directed IRA will be the investor and will have its own name and tax ID number. You will essentially be creating a

new entity to hold this asset.

2. Funding the account. This is the most difficult and time-consuming part of the process. This should be done on a custodian to custodian basis; you cannot initiate the transfer of funds. The administrator/trust company will affect this transaction; however, 401(k)s and most other employer-sponsored plans can only be rolled over into your new self-directed account, if allowed. Rollovers must be initiated by the account holder (you) by instructing the former custodian to distribute the funds.

Transfers from “like IRA to like IRA” are initiated by the administrator/trust company and typically take 2 to 6 weeks. Ask your current custodian if they require a Medallion Guarantee Stamp and an original transform form, as well as if they will accept a fax request. You may also fund the new self-directed account with new funds (personal or business check). Your contribution limits and eligibility depend on your unique financial circumstances; your tax or financial advisor can guide you regarding eligibility. These transfers are tax free; the tax-deferred accumulated value is assigned to the new account.

3. Making a self-directed transaction/purchase. This is the fun part! There are many alternative assets that may be included in a self-directed retirement account. It is up to the individual account holder to do all the necessary research and due diligence about these investments.

Based on your instructions, the administrator/trust company will:

• Send you forms to complete & request any documentation needed
• Send out the funds
• Review each transaction to ensure it meets IRS guidelines
• Ensure the tax-advantaged status of your IRA is protected
• Make you aware of ERISA (Employee Retirement Income Security Act) guidelines
• Ensure you avoid prohibited transactions that involve disqualified entities

How does my retirement account accept returns/dividends from my investments?

Like your traditional IRA account, this account and its holdings (short-term vacation rental property) will hopefully increase in value and generate a decent return on investment. However, unlike your original IRA where the account’s earnings are “plowed back in and reinvested,” that can’t happen with real estate. In the case of a real estate-backed self-directed IRA, those earnings are paid to the newly created account with the administrator/trust company. You can leave it “on account” or do a new tax-free transfer to a traditional IRA investment.

What to Look for in Self-Directed IRA Administrators/Trust Companies:

• Length of time in business
• Level of expertise and real estate specialization
• Where they do business
• Fees and charges (some have A LOT)
• Services offered

Do your homework and check out many companies. Ask for references and ask to speak with one of their real estate IRA owners to get a firsthand review.

Short-term Vacation Rental Property Considerations:

• Rental / guest income: All net income, after management commissions and fees, will be forwarded to the account’s administrator/trust company for disposition. It can’t be paid to you or redirected to another IRA account.
• Short-term vacation rental property expenses:
  • Property Management Commissions and Fees - deducted from the property’s gross rental income; management company will provide your administrator/trust company with an accounting of such charges on a monthly, quarterly and/or annual basis

Paid by the administrator/trust company on behalf of the IRA owner:

• Property Insurance
• Property Liability Insurance
• Property Taxes
• Utilities including electric, gas, CATV, internet, phone, etc.
• HOA Fees, if applicable
• Property Repair, Updates, Rehab, Furnishings, etc. - OR deducted from the gross rental income by the property management company

Short-term Vacation Rental Property Income Taxes

This account and the entity that owns is typically free from any current income taxes (state and federal). However, you MUST work with your account’s administrator/trust company and qualified tax professional to ensure that all ownership rules are followed.

NOTICE: Investment and/or tax planning information included in this paper is not specific investment or tax planning advice. Each situation is different; please consult a professional, competent, and licensed individual for tax, legal, or investment advice.