Real Estate In Your IRA?

“Buy a rental property with my IRA dollars?!?!? Why didn’t I think of this great idea before?”

About 2 times each year, we are asked about the possibility of using IRA dollars to buy a piece of real estate. Over the last 30 years, we have yet to see someone navigate this rather risky process successfully. IRS rules regarding IRAs are stringent, and placing a property inside an IRA tends to be the same as trying to use a snorkel in a sandbox.

A partial list of reasons why…

1. If you step on one of the IRS landmines, BOOM!……the whole IRA gets “disqualified”…..which means your IRA is suddenly slaughtered by taxes.

How can this happen?

If you combine your personal dollars with your IRA dollars: Need a new HVAC system at your rental property? Or need to pay a handyman for a repair? You must do so out of the IRA dollars, and not out of your checkbook.

Self-dealing: You cannot live at the property, or vacation there. Neither can your family members. Not at all. And you can’t run any part of your business out of the property. The IRS considers that self-dealing, which is basically doing business with yourself/your family. If caught doing so, your IRA gets disqualified.

Labor investment: Does the property need repairs or renovations? You and your family members cannot perform the work. None of it. What if you own a plumbing business and want your company to put in a new sink? Nope. You, your family, and your business all fall under the “disqualified persons” definition. You must hire a disinterested third party, and pay them standard market rates, to do any work on the property.

2. Concentration risk

Odds are that if you are using IRA assets to buy real estate, it is because you don’t have sufficient assets outside your IRA to do so. This should give you pause. “Is it actually smart for me to do this?” All your eggs may truly be in that one basket.

3. Bye-bye tax benefits

One of the reasons people buy real estate is for the tax advantages. Depreciation, tax deductions, loss deductions if cash flow is negative, etc. But you cannot leverage these tax efficiencies if the property is inside your IRA.

4. Required Minimum Distribution (RMD) rules don’t go away just because you bought real estate

If you buy a property inside your IRA, and then somehow successfully navigate your way through the labyrinth of rules, eventually you will reach the age (in your 70’s) when the IRS starts forcing you to take money out of your IRA every year. Is your IRA money tied up in a property? The IRS doesn’t care. They expect you to fire sale the property so you can execute your RMD before New Year’s Eve.

6. No leverage

Since 1891, the value of the average home in the US has grown at about +3.1%/year (source: Case-Shiller & The Bureau of Labor Statistics). But that return has been amplified for the average homeowner through leverage. Using a mortgage means you only have to invest a fraction of your own dollars to control the property. That makes the growth more powerful, since you only had to put up a small amount of your money to get it. But borrowing in an IRA is almost impossible.

7. You have to use a Self-Directed IRA

To put real estate in your IRA, no normal IRA custodian will touch it. So you have to open a self-directed IRA. One in which you bear all the risk for sticking to the IRS rules……..and suffer all the punishment if you do not.

Questions? As always, we are here to help you.

Authors: Rick Wagner & Keith Wagner

Source: The Internal Revenue Service.

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