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What is an IRA?
The abbreviation IRA stands for an Individual Retirement Arrangement. There are two types of IRAs: Traditional and Roth . A traditional IRA is sometimes tax-deductible, which means you do not pay taxes on any money you invest. You will however pay taxes on the gain.
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What is a Roth IRA?
A Roth is a type of IRA in which money is taxed as income the year it is contributed. Any gain, however, is not subject to any income tax the year it is withdrawn. So if you are eligible to contribute to either a regular (Traditional) IRA or a Roth, you should most likely do a Roth contribution because the growth in a Roth is tax-free. A regular or traditional IRA can be converted into a Roth IRA in many cases; however, taxes must be paid at the time of the conversion. One option that appeals to many investors is to convert only a percentage of your regular IRA to a Roth in any given year, until all of it has been converted. That way, you don't pay so much in taxes in any one year.
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Why haven't I heard of this?
Contrary to what you have heard or been told you absolutely can. Numerous brokerage firms, mutual fund companies, and banks may tell you "No, you cannot do that" or, "there are no administrators that allow real estate holdings in IRAs." They are 100 percent wrong! The IRS places very few limits on what you may invest in using you IRA funds. It is your IRA custodian who has put the limits on your IRA accounts. IRA investments are not limited by the IRS, they are limited by security-based custodians. These custodians have no interest in educating their clients in alternative investments. Retirement investing has been dominated by the securities industry since 1974; however, recently IRA money is being invested in real estate through self-directed custodians at an accelerated pace (35% growth rate in 2005).
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What if my CPA says I can't buy real estate in a retirement account?
This is not uncommon. The option of investing IRAs in real estate has been an unintentional secret that many real estate, legal, and tax professionals do not know about it. Very few financial professionals and advisors are well-versed in the process.
Section 408 of the Internal Revenue Code does allow real estate investing in an IRA. It's as simple as that. There are certain investments that are not allowed in IRAs, including life insurance and collectibles. The IRS has had this question so many times that they answer it directly on their website (www.irs.gov).
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What are the requirements associated with buying real estate with a qualified plan?
When purchased, these properties become assets of your Plan or account. Fundamentally, your retirement plan is intended to benefit you when you retire, and not before then.
In addition:
- It must be for investment purposes only.
- Neither you, your spouse, nor your family members (other than siblings) may have owned the property prior to its purchase by your Plan.
- Neither you nor your family members (other than siblings) may live in or lease the property while it's in your Plan.
- Your business may not lease or be located in or on any part of the property while it's in your Plan You may receive any property as a distribution from your Plan as a retirement benefit.
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I have funds in an old employer's 401(k) plan (or other qualified plan). I would like to use those funds to invest in real estate on a tax deferred basis. How do I proceed?
You may roll these funds into a traditional IRA, or qualified plan (if you are eligible to have a qualified plan) which permits complete self direction. You should contact your old employer's plan administrator or benefits department to determine what, if any, special procedures may be required.
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What are the fees associated with holding real estate compared to those for holding securities?
Fees can be less on real estate assets than other securities, but in general they are equivalent. In many cases, custodians charge one of two ways for the assets they hold: either based upon dollar value of the account, or the number of transactions in the account.
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Why do you sometimes use the term 'retirement account' and sometimes the term 'IRA?' Is there a difference?
The two terms are sometimes interchangeable but not always. An IRA is always an Individual Retirement Arrangement (or Account .) However, a 'retirement account' may apply to either an IRA or an employee-sponsored qualified plan such as a profit-sharing or
401(k) plan. Therefore, when we use the term IRA we include all forms of Qualified Retirement Plans:
Keoghs Profit Sharing Money Purchase
401(k) 403(b) 457
SEP IRA SAR SEP Thrift Saving Plans
Simple IRA Traditional IRA Roth IRA
Spousal IRA Conduit IRA Qualified Annuities
as well as: Coverdell Education Savings Account and,
Salary Deferral 401(k) Plans
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Why buy real estate?
Through a Self-Directed IRA/401k you can purchase investment property, condos, multi-family units, and land just to name a few. Real estate, over any other investment, has the potential of increased safety of principle (tangible asset), income (rent) and growth (appreciation) all wrapped into one investment. For the income investor, a Self-Directed IRA/401k also allows you to loan money in the form of a mortgage (secured by real property) at interest rates far superior to those of traditional investments.
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Why buy real estate in an IRA or 401(k)?
The simple answers…
- An alternative to traditional investments that are often difficult to understand, monitor, and value.
- A means for growth and income through a tangible, less volatile investment vehicle.
- Tax free or tax deferred (depending on the status of your individual plan) growth and income without complicated 1031 exchanges or other tax strategies.
- Diversification, Diversification, Diversification!!!
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Can I buy and sell real estate in my IRA?
Yes. As a matter of fact, many investors buy and sell multiple times. Since you don't incur any current taxation on gains and income in the IRA, it's a good opportunity to build wealth. If you happen to have a Roth IRA, you will never be taxed on gains in the account when distributed properly.
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How do I purchase and sell my real estate investments?
It is important that you work with a Realtor who understands qualified plan purchases. A real property purchase or sale is initiated by executing either a Buy or Sell Direction Letter For Real Estate. The property is purchased in the name of your IRA. All contracts and addendums must be filled out accordingly. Property that was previously owned by you is disqualified and may not be placed into your IRA. The simplest way to purchase the property is with the cash available in your retirement account.
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How many IRA accounts can a person have?
You can have as many accounts as you like, although each one will probably charge annual account fees, so it would be recommended to have two accounts, one for real estate and one for other investments such as securities, although most self-directed custodians will do both.
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Can I leverage (mortgage) the purchase?
Yes. You may finance or leverage any property you purchase within your account. The loan must be a non-recourse loan. This is not your traditional mortgage. The only "recourse" the lender has to satifiy the debt is the property and/or the rental revenue that the property generates. Be sure that you work with a lender familiar with non-recourse lending. As the property is an asset of the Plan, repayment of the underlying debt must come from contributions to or income from the property or other assets in the Plan. This will trigger certain additional taxes and should be well understood by you and a CPA prior to purchasing a property.
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Can I purchase a home now that I want to live in after retirement?
Yes, however you cannot use that home for any personal benefit while owning it in the IRA. After age 59˝, you can 'take distribution' of the property and pay the taxes (if applicable) you would normally pay on the growth of the IRA. Of course, if you have purchased the property in a Roth IRA, there will be absolutely no taxes due at distribution.
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What are the steps to transferring from one custodian to another?
Transferring all or part of your current IRA to such a custodian is a simple process. The paperwork is initiated by the new custodian, who contacts your current custodian to make the transfer.
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What are 'Prohibited Transactions'?
Internal Revenue Code Section 4975 contains rules on prohibited transactions, which generally involve one of the following:
1) Doing business with a 'disqualified person' which includes you, your spouse, and some family members. (For example, you can't sell a property you already own to your IRA.)
2) The primary purpose of the IRA investment must be to benefit the IRA account itself, not another person. (For example, you can't use the property to your benefit by establishing it as your residence.)
3) You cannot borrow money from your IRA, nor can you borrow money secured by your IRA.
4) You cannot purchase life insurance or collectibles in the IRA; collectibles include works of art, antiques, metals, gems, stamps, or alcoholic beverages.
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How do I ensure compliance with IRS regulations?
The entire transaction must flow through the tax-free or tax-deferred retirement account. The escrow must be opened by the account. Only Qualified Plan or IRA funds may be used as good faith deposits, down payments, or money purchase. Always consult a CPA before assuming that a particular tax law pertains to your individual situation. If title is vested in individual account holder names, it may not be subsequently sold to the tax-deferred or tax-free account.
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What about property appraisals?
That can vary depending on the custodian. Some will require an appraisal at specific times, for example, every three years. Others will use the initial appraisal and an annual formula update. Others only require an appraisal if the property is being purchased, sold, or if the IRA owner is over age 70˝ and required minimum withdrawals must be taken. Also, if the IRA owner wants to take distribution of the real estate in the account to use it personally (usually after retirement) an appraisal must be done at that time. You typically select the certified appraiser.
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Is liability insurance required?
Yes. Proof of liability insurance is usually required in order to process the purchase and must be carried on the property at all times. This applies to all types of property including raw land. No different than any other real estate you own.
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Do the custodians give investment advice?
No. Your choice of real estate will be held by the custodian for your benefit but they do not give investment advice. Usually local Realtors are most savvy as to market conditions, while the Custodian is an expert in administrative issues.
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Can I purchase part of a property with my IRA?
Yes. While fractional interests in real property may be purchased or sold, such interests may not be bought from the beneficial owner of the Plan or IRA or family members of lineal decent. In many instances, it is best to consider forming an LLC and having your qualified plan own a given percentage of that LLC. Either your attorney or one in our network of professionals can assist you in determining the best method of ownership. Therefore, you, relatives, friends, business associates, et. al could get together and use your separate IRAs, and discretionary funds as well, to purchase the real estate of your choice.
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What about Required Minimum Distributions?
Required Minimum Distributions (a.k.a. RMD) are required at age 70 ˝ for anyone who owns a Traditional IRA (not a Roth.) At the time of distribution, you would want to have enough cash in your IRA to take the required distribution, or if you have maintained more than one IRA account, it can be taken from that account as well. The values of all IRA accounts are totaled as of year-end, and RMD amounts are calculated from the accumulated value of all IRAs.
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What about needing closing attorneys and title companies?
All contracts, deeds and other official documents must be filed in the name of your qualified plan. Improper filing may disqualify a property and result in fines or additional taxes to you or your plan. Be sure the attorney or title company that you choose is well aware of the filing requirements.
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Can I managing the property myself?
No. It is important to find a property management company who understands real estate IRA holdings. All of the income and expenses are for the benefit of the account. This includes all property rental or lease income, taxes, property management and repairs. Invoices for expenses are paid on client approval. The record keeping and administration expenses may be paid either directly from separate funds or through the Plan, and may be tax deductible. Management fees can be paid to entities you designate on receipt of invoices. A 1099 will be issued to your designated asset managers for the year in which such invoices are paid.
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Disclaimer: The information contained in this site is provided for general information only and should not serve as a substitute for legal advise from an attorney familiar with the facts and circumstances of your specific situation. The Laurel Group of Prudential Fox Roach performs real estate and business brokerage transactional services. | 
