Real Estate IRA Funds Accounting Tips
Self-directed retirement accounts that hold real estate are commonly called real estate IRAs. The administration and functionality of real estate IRAs are the same as any other self-directed account. Account owners identify real estate-related investments they wish to acquire based on things they know and understand while retaining absolute control over their own funds and acquisitions. However, it is important to understand how to manage the flow of income and expenses when it comes to real estate IRA funds.
How to Pay Bills and Receive Income for Real Estate IRAs
When you hold real estate in an IRA, there are common sources of income and expenses that occur. Some examples include rental income from tenants or having to pay for maintenance on the property. Before we discuss income and expenses, we will discuss prohibited transactions and parties to be aware of.
Rules and Regulations
Let’s get all of the rules out of the way. Even though real estate IRAs give account holders freedom and control when investing, you should be aware of certain transactions and dealings with specific individuals that are prohibited. A list of prohibited transactions that should be kept in mind to prevent your IRA from penalties or disqualification include:
- Sell, exchange or lease property to yourself
- Vacation in, or otherwise use, property owned by the IRA
- Allow disqualified persons to vacation in or use property owned by the IRA
- Buy, sell or lease property from a disqualified person
- Receive compensation for managing property in the IRA
- Perform maintenance on the property held within the IRA
- Use the IRA property as security for a loan
- Borrow money from the IRA
- Transfer plan income or assets to disqualified persons
- Lend money to disqualified persons
- Furnish goods, services, or facilities to disqualified persons
- Allow fiduciaries to obtain or use the plan’s income or assets for the IRA owner’s interest
The list of disqualified persons involved with an IRA includes:
- The IRA holder and his or her spouse
- The IRA holder’s lineal ascendants, lineal descendants, and spouses of lineal descendants
- Investment advisors and managers
- Any corporation, partnership, trust, or estate in which the disqualified person maintains control as a president, manager, etc.
- Anyone providing services to the IRA, such as the trustee or custodian
Know How Expenses Flow In and Out of the IRA
All income expenses must flow directly in and out of your IRA. Midland IRA, as the administrator of your account, receives and deposits income to your IRA and pays the expenses from your IRA. Improper handling of IRA expenses and income can lead to problems for the IRA holder and can lead to the IRA losing its tax-advantaged status. You cannot personally deposit the rent or pay the expense. Your IRA administrator or management company must control all the funds.
An IRA owner cannot receive a personal benefit from their IRA. This includes taking income directly from IRA assets, such as real estate. These actions could result in a punishment of a forced distribution from your IRA.
Using Midland360 and Midland Pay to Manage your Real Estate IRA Funds
Midland has made managing the flow of expenses for a real estate IRA even easier for our clients. By using the Midland360 Online Portal, clients can update their account information, view billing-related topics, initiate sending funds from their account for bill payments, distributions, and investments, view account activity, and view account documents.
In addition to the Midland360 Online Portal, we also offer the Midland Pay app in the Apple and Google Play stores. The app allows tenants of Midland account holders to quickly and easily pay rent or note payments securely via direct deposit (ACH) at no additional cost to our clients or their tenants. Midland Pay features include:
- Sending rent and note payments via ACH
- Paying as a guest
- Creating an account to send future rent payments
- Sending a one-time payment
- Scheduling recurring payments
- Viewing payment history
- Easily searching for the property or note to be paid
Options to Handle Income and Expenses
There are multiple ways that you as the IRA owner can handle your real estate accounts. These options include handling the accounting yourself, hiring a property manager, and forming a single or multi-member LLC. As always, it is important as the IRA owner to know how the transactions flow through the IRA with each option and the prohibited transactions/disqualified parties related to each.
Handle Transactions Yourself On Behalf of Your IRA
When handling a self-directed IRA on your own, it is important to remember that you can handle property management but cannot perform sweat equity or pay for expenses out of your own pocket. By ensuring that every expense flows through the IRA account and you do not perform your own maintenance on the property(ies), you will avoid prohibited transactions.
The best way for an IRA owner to handle transactions themselves is to utilize the Midland360 Online Portal or the Midland Pay app in the Apple and Google Play stores. These two platforms allow IRA owners to make one-time payments or set up recurring payments. The portal comes in handy for IRA owners when single expenses come up to be paid by the IRA, such as a water heater replacement. Recurring payments can be set up by tenants themselves to allow monthly rent payments to flow directly into the IRA.
Use a Property Manager to Manage All Income/Expenses for the Account
Since IRA owners are not allowed to perform any sweat equity or pay expenses out of pocket, many choose to hire a property manager to oversee the property(s). While this is not required, it is a way to make the process easier and to avoid prohibited transactions.
When hiring a property manager, they must be paid by the IRA. They may be able to do repairs or hire professionals to do the work, but any expenses incurred by them (including their salary) must flow in and out of the IRA.
Form a Single-Member LLC
These accounts are known as single-member LLCs or checkbook control IRAs. This arrangement gives the self-directed IRA owner what is commonly referred to as “checkbook control.” By creating a new LLC and having the IRA as the sole member of the LLC, the IRA owner acts as manager of the LLC. A bank account can be established for the LLC in the name of the IRA, which allows the IRA owner to write checks directly to purchase investments.
Typically, these account structures are used by individuals who are holding rental properties in the LLC or by individuals who are purchasing multiple assets. Such transactions require a great deal of accounting and the IRA owner is responsible for keeping complete and accurate records. Forming an LLC creates an additional cost and entails a supplementary set of rules that must be followed. Consult with your attorney, CPA, or other financial professional to determine if using a single-member LLC is right for you.
Form a Multi-Member LLC to Pool Various IRAs/Investors/Personal Funds
Closely-held LLCs can refer to an LLC or partnership in which a group of people owns different types of investments. Closely-held LLCs offer a great deal of flexibility for IRA investors. Closely-held LLCs can include single-member LLCs, but typically we are talking about multi-member entities. However, additional responsibilities and rules surround these investments and the setup of the entity.
If choosing to invest through a multi-member LLC, there are no limits on who can be members of the LLC. Anyone can be the manager of the LLC, but it is always important to remember that if the manager is a disqualified party that person cannot be compensated for managing the LLC. We encourage clients to speak with their advisors in regards to detailed questions on the LLC’s management.
There are three basic steps to investing in a multi-member LLC:
- Open and fund the self-directed IRA at Midland using our online application.
- Create or obtain the required LLC documentation. For a multi-member LLC, Midland requires a copy of the LLC operating agreement, articles of organization or incorporation, and a schedule of members showing the IRA titling or titlings listed as a member with the percentage ownership and capital contributions specified. Once ownership percentages are established in the LLC, they cannot be changed. The LLC manager and IRA owner may wish to work with an attorney to establish the LLC or if they have in-depth questions about structuring.
- Once all of the LLC and Midland purchase authorization documents are received and in good order, we will be able to process the investment the next business day and send the funds to the LLC bank account. From there, the manager of the LLC will move forward with the investments through the LLC.
It is crucial for the IRA owner and the LLC manager to be aware and familiar with disqualified parties and prohibited transactions. Should there be a capital call or any other need to send additional funds for the IRA’s investment in the LLC, funds will need to first flow through Midland. If there are disqualified parties who are also members in the LLC, they too will need to send funds equal to their percent ownership to prevent any unintentional transfers of ownership.
MIDLAND TRUST COMPANY, NOR ITS AFFILIATES OR SUBSIDIARIES (COLLECTIVELY REFERRED TO AS “MIDLAND”), IS NOT A FIDUCIARY: Midland’s role as the Custodian and/or Administrator of self-directed retirement accounts is non-discretionary and/or administrative. The account holder or his/her authorized representative must direct all investment transactions and choose the investment(s) for the account, and is responsible for conducting his/her own due diligence. Midland has no responsibility or involvement in selecting or evaluating any investment and does not conduct due diligence on any investment. Nothing contained herein shall be construed as investment, legal, tax, or financial advice or as a guarantee, endorsement, or certification of any investments.