Real Estate in an IRA
Did you know you can use your IRA to
purchase real estate? You can, but its important that you follow
some basic rules or you risk the IRS disqualifying your entire IRA!
Read on to learn more.
You will probably need to change your IRA custodian. Most banks and
brokerage firms dont allow non traditional investments in their
IRAs, including Fidelity, Schwab, Vanguard and T. Rowe Price.
Other custodians specialize in serving as the custodian for IRAs
holding non-traditional investments. (You can find many by typing in Real Estate IRA Custodian in your favorite internet search
engine.) The fees charged are higher and may amount to hundreds of
dollars a year to thousands of dollars a year based on the value of
the account.
In these accounts, your IRA can own apartments, single-family homes
and duplexes. Your IRA can own raw, undeveloped land or commercial
property but it cannot directly benefit you or your relatives. You
cant rent from your IRA.
The process is involved, but straight-forward. You open an IRA
account with the new custodian and transfer funds from an existing
IRA. You can use the new custodian for your entire IRA or just a
part. I would recommend using a traditional custodian for that
portion of your IRA that uses investments like stocks, bonds, and
mutual funds.
You then identify the property you want to buy and the custodian
purchases that property on behalf of your IRA. The custodian does
not provide any management of the property, thats left up to you.
Say your IRA buys a duplex to serve as a rental. Even though your
IRA owns it, you would still be the one responsible for finding
tenants, arranging leases, getting insurance, making repairs and all
the other things associated with being a landlord. Conversely, you
can hire a property management company to do this on behalf of your
IRA.
It is extremely important that you only use IRA funds for all
expenses associated with the ownership and management of the
property, including taxes, repairs and insurance. The rents received
flow into the IRA account and that money can then be used to cover
these costs.
If you mix personal funds and IRA funds together you risk
substantial penalties that may include your entire IRA being
disqualified by the IRS. That means you would immediately have to
pay ordinary income tax on all the money in your IRA, plus other
penalties and interest. Dont invest all of your account’s funds
into real estate, but leave a cushion to cover normal operating
costs. The amount you leave as a cushion will depend on the type of
property and the expenses associated with it.
Its also important that you dont borrow money within the IRA to
purchase property. Income from a debt-financed property within an
IRA is subject to unrelated business taxable income (UBTI). Your IRA
will then have to file a tax return and pay income taxes on those
‘profits’.
Taking Required Minimum Distributions from an IRA invested in real
estate can be a problem unless you plan ahead. If you are 70 % (or
as you approach that age), build up an extra cash cushion in the
account to cover your RMD each year.
If all of your IRA is invested in raw land and you dont have enough
liquid investments to cover your RMD, then you will have to withdraw
a piece of that property. You do this by deeding a portion to you as
an individual. This creates potential problems because you have to
have appraisals done to insure that the land withdrawn was properly
valued. It also involves lawyers, deeds and recording fees.
For those experienced in real estate, it makes perfect sense to own
some in their IRA. Those without experience should think long and
hard about it before they do. I suggest you consult a CPA
knowledgeable in this area prior to making your first purchase.
Its also not worth it for small IRAs. Diversification is still
important in real estate so you will want to own more than one piece
of property. Your IRA should also have a portion invested in
traditional, more liquid investments such as stocks, bonds and/or
CDs.
Courtesy of Jeff Voudrie CFP
Jeff will also answer your financial planning questions at
www.guardingyourwealth.com
