The auction market has been seeing an uptick in activity, especially with current housing trends and increasing interest in alternative investment opportunities.
For IRA investors, the auction process offers unique ways to acquire property, but it’s important to understand the various steps involved to ensure a smooth experience.
Whether you're considering court auctions or online auctions, hopefully you’ll gain a better understanding and overview of the key processes, requirements, and best practices.
In-Person Vs. Online Auctions
The two primary types of auctions for investors are court and in-person auctions (typically held at courthouses or event spaces) and online auctions (typically hosted on platforms like auction.com). While both offer opportunities to acquire real estate, the process, required documentation, and timing differ significantly.
- In-Person Auctions: Typically involve live bidding on single-family homes, commercial properties, farm, ranch, or recreational land as well as foreclosed properties. Bidders must show up in person and bring the necessary funds in the form of certified or cashier’s checks.
- Online Auctions: These are conducted through online platforms where investors can place bids remotely. These auctions tend to have more structured processes and often involve more paperwork, including deposits and escrow, but often allow a longer period to provide funds and to close on the property with the flexibility of using a wire transfer.
Many first-time investors enter auctions with excitement, but without the proper research or support, they can open doors to risks and detrimental mistakes.
The Importance of Due Diligence and Avoiding Common Mistakes
Byron Menke, Broker Owner of Menke Auction & Realty, is a seasoned real estate auction professional with years of experience in leading and participating in real estate auctions. He shared some of the most common mistakes he sees from new investors, along with some key advice on how to avoid these pitfalls:
Mistake #1: Bidding Without Proper Representation
One of the biggest mistakes Byron sees from first-time investors is attempting to bid without proper representation. Auctions are often fast-paced, and the legal and financial complexities of bidding can be overwhelming for someone unfamiliar with the process.
Byron’s Tip: "I can't stress enough how important it is to have someone on your side who knows the ropes. Not having the right representation can lead to disastrous mistakes. You might win the auction but end up stuck with a property full of hidden liens or legal issues. Always work with a professional who understands the auction process, whether it's an attorney, real estate agent, or auction expert."
Mistake #2: Failing to Research Liens and Property History
The most significant risk of purchasing auctioned properties is inheriting hidden damages, liens, or unpaid mortgages. If you don't do your homework, you could end up acquiring a property with significant financial obligations attached to it.
Byron’s Tip: Be sure to have a local Title or Escrow company research the property to discover all judgments and liens attached to the property and determine which ones will transfer with the property to you as the buyer. Also have them search for any easements which may negatively affect the value of the property.
Mistake #3: Being Rigid and Not Remaining Flexible
Auction bidding is unpredictable. Sometimes, properties may not meet the reserve price, or there could be a shift in bidding strategy mid-auction. Investors who aren’t flexible may end up overbidding or losing out on a potential deal.
Byron’s Tip: First determine if the auction is an “Absolute*” auction or if it is being sold “With a Reserve” so there are no surprises. Do your research with the help of a real estate professional who knows the market in the area and is an expert in the type of property you are looking to purchase.
*An absolute auction, also known as a no-reserve auction, is a public sale where an item or property is guaranteed to be sold to the highest bidder, no matter how low the final bid is.
How the Self-Directed IRA Auction Process Works
Auctions are straightforward but require a thorough understanding of how to pay and what documentation is needed when using your Self-Directed IRA. Here’s how it typically works:
- IRA Establishment: Open a self-directed IRA account with your preferred custodian and ensure the account is funded.
- Bidder Registration: Investors must register with the Auction company or entity conducting the auction to ensure they are authorized to bid at the auction. A bidder registration is typically required in the name of the IRA, and this must be done ahead of time.
- Payment: Investor must request and complete Real Estate Auction Buy Direction Letter from their custodian.
- Pro Tip: Request and bring checks made out in increments (for example, multiple checks of $10,000 to cover a total bid of $100,000). This is done to avoid overpayment to the auction if the final bid is under $100,000.
- Registering for Online Auctions: Investors must register for online auctions in the name of their Self-Directed IRA. Once registered, the bidding process is similar to traditional auctions but done remotely.
- Deposit and Closing Process: If the investor wins, they must send an Earnest Money Deposit (EMD) within about 3 days. After this, the process proceeds similarly to a standard real estate transaction, with title work, escrow, and a 30-45 day closing period.
Online auctions are becoming increasingly popular due to their convenience, but they do come with additional steps. Here’s what you need to know:
Refunds and Overpayments
One common question from investors is what happens if they overpay for a property at an auction. Here’s what you need to know:
- Overpayment: If an investor overpays at an auction, the county will issue a refund for the excess amount. However, this refund must be made out to the IRA, not the individual investor.
- Timing: The investor has 60 days to return any unused funds directly to their IRA through the custodian, not deposited into the investor’s personal account; otherwise, the funds may be considered a distribution and subject to taxes.
Best Practices and Tips for IRA Investors
If you’re considering using your IRA to participate in auctions, here are a few tips to help ensure a smooth process:
- Know the Rules: Whether bidding in-person or online, make sure you understand the rules regarding payment, registration, and third-party bidding. Ensure you’ve registered for the auction in advance.
- Do Your Due Diligence: Before placing any bids, carefully research the properties you are interested in to ensure you are aware of any liens or legal complications. Bring your research notes, including title reports, lien checks, and market value data.
- Proof of Funds: The IRA funds should be funded prior to entering the auction. Have your custodial and IRA information ready, including any checks or proof of available funds for the deposit.
- Understand the Timing: Be aware of the 60-day deadline for returning unused funds to your IRA to avoid penalties.
- Seek Guidance: Above all, work with a trusted professional and remain flexible. Be ready to pivot or walk away if the bidding doesn’t align with your goals. Many first-time investors enter auctions with excitement but without the proper research or support.
- Legal Documents (if applicable): If you're working with a third party, bring the necessary agreements in writing.
Why Now Might Be the Right Time to Invest
As the housing market continues to shift, investors who understand how to use an IRA in a real estate auction, along with the risks involved, could find themselves in a prime position to acquire undervalued real estate.
Whether the auction is court-based or online, understanding the process and preparing in advance can help you avoid costly delays or complications.
Planning to bid at an upcoming auction? Contact IRAR before you bid to make sure your IRA, documents, and funding are ready.
Frequently Asked Questions
Can a self-directed IRA buy real estate at an auction?
Yes. A self-directed IRA may purchase real estate through an in-person or online auction, provided the custodian accepts the investment and the transaction follows IRA rules. The account should be open and funded before bidding begins.
How should I register for an auction using my IRA?
Register in the name of your self-directed IRA using the ownership information provided by your custodian. Confirm the auction company’s registration requirements and submit any required documents before the deadline.
Can I use personal funds for an auction deposit?
Auction deposits and purchase expenses should generally be paid with funds from the IRA. Contact your custodian before using personal funds or making a payment on behalf of the IRA.
What due diligence should I complete before bidding?
Review the property’s title, liens, unpaid taxes, easements, condition, market value, auction terms, and estimated closing costs. A self-directed IRA custodian holds the asset but does not evaluate the property or determine whether it is a suitable investment.
Can I personally use a property purchased by my IRA?
No. Property owned by an IRA cannot be used for the personal benefit of the account holder or another disqualified person. Prohibited transactions may create serious tax consequences for the IRA.
What happens if the IRA overpays or the auction deposit is refunded?
Any refund should be made payable to the IRA and returned directly to the custodian. The refund should not be deposited into the investor’s personal account. Contact the custodian promptly for the correct return instructions.
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