Real Estate In An IRA

Did you know you can use your IRA to purchase real estate? You can, but it’s 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 don’t 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 can’t 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—that’s 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. Don’t 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. It’s also important that you don’t 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 ½ (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 don’t 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. It’s 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. Have a financial question? Send me an email and I’ll personally respond, free of charge. Go to www.guardingyourwealth.com and click on ‘Ask Jeff’. In addition to being a nationally syndicated columnist and Certified Financial Planning Practitioner, Mr. Voudrie provides personal, private money management services to clients nationwide.