August 11, 2013 in Business

Vacation investments require alternative financing methods

Tom Kelly
 

Not everybody qualifies for a loan – let alone on a property other than a primary residence.

If you have been turned down for conventional financing on a vacation investment property there are alternative methods, including individual retirement accounts and tax-deferred exchanges from commercial properties. Unlike other strategies like reverse mortgages and seller financing, real estate IRAs and tax-deferred exchanges apply only to investment properties with no personal use allowed.

The rules for purchasing real estate with an Individual Retirement Account are specific and differ greatly from those that govern conventional rentals and second homes. For example, you cannot buy a second home with an IRA and use it partly for personal use, even though you might rent it to unrelated persons the rest of the year.

And, an IRA cannot purchase a real estate asset and then have a “disqualified” person (family member) use it while it is in the IRA. The purchase must be for an investment property and no personal use – until retirement. Then, the individual can move in to the property and pay tax as if taking a disbursement from a conventional account.

Self-directed real estate IRAs are not only relatively easy, but they are also not subject to some of the guidelines that apply to employee-sponsored qualified plans enforced by the Department of Labor.

To prepare for your real estate IRA, designate the amount of your retirement funds that you wish to use in the property deal and open a new IRA account with an independent administrator. Three national firms handling real estate IRAs are Entrust Administration – www.entrustadmin.com; Guidant Financial – www.guidantfinancial.com; and Pensco Trust – www.pensco.com

According to Joe DiDomenico, business development manager for The Entrust Group, some self-directed IRA clients are actually buying their future retirement home at today’s prices in highly desirable locations.

“They’re renting out the place for now and will claim occupancy after they take their final distribution after the age of 59½,” DiDomenico said.

The guidelines covering real estate IRAs are stringent. If you break one of these rules, you could jeopardize your tax-free status on your account.

The land or house must be treated like any other investment.

All rental profits must be returned to the trustee.

You cannot manage the property. But your trustee can hire a third party – a real estate broker, or local manager – to collect rents and maintain or improve the property.

The house or property (or proceeds from its sale) must remain in the trust until distribution at retirement. If the trustee is instructed to sell the property, funds can be transferred to another account for reinvestment.

You cannot use IRA money to buy your own residence or any other property in which you live. It has to be investment property. But when you retire, you can direct your IRA to turn it over to you as a distribution at the current market value.

If you are convinced a piece of real estate will undoubtedly appreciate, check in to a real estate IRA. You, too, could buy low and sell high.

A tax-deferred exchange (commonly known as IRS Section 1031 Exchange) is really an arms-length sale and purchase. The transaction proceeds just as a sale for you, your real estate agent and parties associated with the deal. Provided you closely follow the exchange rules, however, the IRS will “sanction” the transaction and allow you to characterize it as an exchange rather than as a sale. Thus, you are permitted to defer paying the capital gain tax.

An exchange occurs when you trade real property that is other than your home or second residence for other “like kind” real property that you have held for trade, business or investment purposes. The like-kind definition is very broad. You can dispose of and acquire any interest in real property other than a home or a second residence. For example, you can trade raw land for income property, a rental house for a multiplex, or a rental house for a retail property.

Maybe it’s time to exchange the one rental you’ve been nursing in town for a golf course condo. You can rent out the condo until you are ready to retire, sell your primary residence and then move into the golf-course condo full time.

Try to look down the road and do the research now on how to get there.


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