Residential Rental — The OUTSIDE® Structure Enables You to Maximize Your Benefits Today While Building Equity for Tomorrow

A residential rental investment is most often a purchase based solely on a business decision with no intention of personal benefit. In some situations the ownership and management of a number of residential rentals is a full time business for the investor. Although personal use of the property may not be a consideration for the residential rental investor, the personal benefits gained from passive income and loss tax rules as well as the rental income itself is of primary concern to the residential rental investor when weighing the differences between a SAFE HARBOR® directed IRA – the OUTSIDE® method, as opposed to a Self Directed IRA – the INSIDE method.

Residential Rental Income Gives Immediate Benefit

Rental income generated by the residential rental property is credited directly to the investor as passive income. Although the IRA is supporting the purchase of the residential rental, rental income is not funneled back into the IRA as it is in a Self Directed IRA. With the IRA supporting the financial obligations of the residential rental, the passive income generated by rental revenue becomes discretionary cash flow for the landlord and does not have to be relied upon to support the overhead of the residential rental property. In times of rental vacancies the IRA becomes a safety net, satisfying the rental’s expenses, taking the stress of slow market conditions away from the landlord.

SAFE HARBOR® Insures Security and Longevity of IRA

Within the structure of a SAFE HARBOR® directed plan the IRA supporting the purchase of the residential rental is placed in an interest earning account where preservation of capital to insure long term support of the real estate purchase is the primary function. Therefore with the OUTSIDE® structure the investor owns two assets concurrently - the residential rental property and the IRA. It is the projected earnings of the IRA combined with the anticipated capital appreciation of the residential rental along with the rental income and tax advantages for the property that must collectively be considered in order to arrive at the benefit to be gained from a residential rental investment configured within the OUTSIDE® structure. Furthermore, the diversification of the concurrent investments offers the investor a greater potential return while at the same time providing broader investment protection.

Residential Rentals — Return on Investment

Let’s first examine the potential capital appreciation of the residential rental investment. Because the OUTSIDE® structure requires the investor to use leverage, the actual cash investment in the residential rental can be a small percentage of the total value of the residential rental investment. Therefore the returns are measured based on what is termed the “cash-on cash” return on invested capital or investment. This method of investing leverages up the percentage of your return. For example, using gross figures for simplicity: A $100,000 property is purchased with $20,000 down, the balance is financed by a traditional mortgage. The property is then sold for a $15,000 gain. A return of $15,000 on a $20,000 investment results in a 75% return on investment, (ROI). (This simplistic example does not take into consideration time held in the investment.) Market conditions can vary widely in different geographic regions and historically housing has experienced periods of escalated appreciation, flat conditions and some periods of value adjustment. Over the long term however, statistics show a nationwide average of an annual 5% appreciation for residential real estate. Secondly, since one of the reasons for purchasing a vacation rental is the income that investment will produce - that income should be considered when making the investment decision.

Now let’s look at the IRA side of the residential rental investment. To comply with the OUTSIDE® structure the IRA must be SAFE HARBOR® directed. The SAFE HARBOR® account offers several different earnings opportunities, all with the necessary requirement of protection from loss of capital. Fixed indexed account opportunities provide unlimited upside earnings potential, however, for the purpose of comparisons in arriving at a residential rental investment decision a conservative 5% annual return should be used.

Residential Rental Income, as discussed in the section above provides discretionary passive income to the landlord and should be figured into the overall calculation of return on investment.

Tax benefits for the residential rental will vary depending upon the eligibility factors of the investor. This can have a significant effect on the return on investment and should be carefully examined for consideration in the investment decision. Those investors familiar with Self Directed or Trustee Directed IRA real estate termed by Uranga & Associates, the INSIDE method, understand the approach of a tax deferred investment. All expenses related to the investment must be paid for from IRA monies and all income related to the investment must return to the IRA. Income tax at the highest rate within the investor’s income tax bracket is paid when the IRA is eventually distributed. For many investors, in today’s tax environment, approximately 40% of the value of their IRA will eventually go to the IRS. Where a residential rental investment is structured by the OUTSIDE® method in a SAFE HARBOR® directed plan, income tax liability on the IRA is satisfied at the time it is utilized for the residential rental investment by applying tax offsets applicable to the investment real estate including depreciation and passive loss exception rules that come into effect for qualifying gross income levels and certain occupations.

Savings in residential rental maintenance expenses can be realized with the ability to self manage the property. When the OUTSIDE® method is applied to a residential rental purchase none of the prohibited transactions enforced in a Self Directed INSIDE structure, apply. This significant difference between the two methods is where the OUTSIDE® method can offer the investor additional savings which will equate to a higher return on investment.