6 Common Questions (and Some Little-Known Facts) About Real Estate IRAs
Many IRA and qualified plan participants are still unaware they can hold real estate in a retirement plan.
Real estate is widely considered to be among the top alternative investments. Many investors transfer or roll over funds into self-directed accounts because their current custodian either won’t allow real estate holdings or because they have little experience with the asset when held inside tax-advantaged accounts.
There’s even a common misconception that owning real estate in an independent retirement account (IRA) is illegal. This is completely untrue. As long as you follow IRS rules, you can own real estate in a retirement account, including IRAs.
Why the Lack of Awareness?
Why are so many still unaware of this investing possibility?
A major reason is that many IRA trustees do not allow IRA owners to invest IRA funds in real estate. Despite the fact that IRA law doesn’t prohibit investing in real estate, trustees aren’t required to offer it as an option, sometimes because of administrative burdens.
If you’re interested in this investment possibility, seek the services of a qualified alternative asset custodian who can handle “administrative burdens” and who permits real estate holdings in its clients’ accounts. Find a custody services provider with the experience and solutions available to provide the best service before, during and after the investment process. And above all, work with a custodian well-versed in real estate investments.
But that’s just Step 1. You also need to educate yourself on real estate investing using retirement funds.
Getting Some Answers
Here are answers to the top questions investors ask about IRA investments.
1. What due diligence should I perform?
While custodians may provide general information on IRS guidelines and walk you through processes, timelines and potential tax implications of an investment, keep in mind that custodians are not tax professionals or investment advisers, so you should seek other professionals to do some due diligence.
There are a number of questions you should discuss with your accountant, attorney and financial adviser:
- Does the investment align with your long-term goals?
- Do you risk creating a prohibited transaction?
- Should you choose
a Traditional or a
Roth account? - Will you have to worry about Unrelated Debt Financed Income (UDFI) or Unrelated Business Income Tax (UBIT)/Unrelated Business Taxable Income (UBTI)?
- Will the investment need more money down the road? When will you start to see a return on your investment?
2. Is investment income really sheltered?
This one may be an eye-opener for you, especially if you are new to investing using retirement accounts. By investing in real estate via a Self-Directed IRA or other retirement plan, returns may be sheltered from taxes. Whether tax-deferred (Traditional) or tax-free (Roth), the profit won’t be as devastated by capital gains taxes. Gains from Traditional IRA investments will see deferred taxation until withdrawals are made from the account. Gains from Roth IRA investments can anticipate tax-free qualified withdrawals.
3. May I manage the property myself?
Technically, this is allowed, but only when it comes to making decisions about the property. Since you may not personally benefit from a property-related transaction, any repairs, improvements and so on must be performed by a non-disqualified person or entity. In addition to yourself, the following are disqualified:
- Spouses
- Parents, children, grandchildren
and their spouses - The IRA’s investment providers or fiduciaries
- Corporations, LLCs, trusts and other entities in which a disqualified person owns more
than 50 percent - Any entity in which the IRA account-holder is an officer, director, a 10 percent or more shareholder, or a highly compensated employee
In other words, you can’t “put a hammer to it” yourself. Additionally, all expenses must be paid by the retirement account, and all income must go to the custodian and back into the IRA (both proportionate to the account’s ownership percentage). It’s best to have a non-disqualified third party manage the property. Visit the IRS website for additional information on non-disqualified/qualified persons or entities.
4. May I use the property myself?
This one’s easy: absolutely not. According to the IRS, using the property yourself is a prohibited transaction. More specifically, doing so would be an indirect furnishing of goods, services or facilities between the IRA and a disqualified person. As the retirement account holder, you’re considered a plan fiduciary and, thus, a disqualified person. Retirement account assets are to be used for investment purposes only.
5. What if I don’t have enough funds to purchase the property in full?
One of the beauties of self-directed investing is the numerous options available. For example, your IRA isn’t required to purchase an entire property outright. You can finance through a non-recourse loan, or your IRA can partner with another entity or entities. You can also invest in real estate crowdfunding opportunities and own a smaller percentage of a property. Other possibilities include real estate investment trusts (REITs) and other stock-market-based investments relative to the real estate industry.
6. Would I have to sell the entire property in order to take a distribution?
No, you don’t have to liquidate 100 percent of your ownership for a distribution. Although you may choose to sell a real estate asset for distribution purposes, many investors don’t realize you can distribute just a percentage of the asset instead. This is often how real estate investors will fulfill IRA-required minimum distributions (RMDs). The percentage distributed must be re-registered to reflect the new percentage of ownership held by the IRA holder. One very important point to keep in mind: Only after you’ve completely distributed the asset may you use the property for personal reasons.
A Bonus
Because question 5 tends to generate follow-up questions, let’s dig deeper into it. Two options, partnering and non-recourse loans, aren’t always apparent to even some of the most-seasoned IRA investors.
First, your IRA can absolutely partner with other IRAs or other investors. Similar to buying fractional shares of certain investments, your IRA may also invest in a percentage of real property. Perhaps your IRA has only enough available cash to purchase 40 percent of a commercial real estate property. The account may partner with another IRA or other investors to purchase the remaining 60 percent. It’s important to note, as question 3 outlines, that all income and expenses must come to and be paid by your IRA according to your ownership percentage.
Also, as previously mentioned, your IRA may secure a loan to purchase a real estate asset. If you don’t have the available funds to purchase 100 percent of an asset, your IRA may be able to secure what’s called a non-recourse loan. The IRA
account holder is not personally liable for repayment of a non-recourse loan. In the event of loan default/foreclosure, the lender must only look to the property as the sole source of repayment and cannot pursue other IRA assets or assets owned directly by the IRA account holder. Not all lenders make this type of loan, however, and those that do often require significant down payment.
Do Your Due Diligence
Have you found commercial space, farmland or rental property you want to hold in an IRA? Regardless of how you choose to invest in real estate with a retirement account, be sure to consult with tax, legal and investment professionals on how best to proceed. These professionals should outline distribution requirements, prohibited transactions rules and special tax circumstances or burdens related to income-producing assets and debt-financed investments. Investing and account-related decisions should be made only after significant research and due diligence.
Don’t forget how important it is to work with a custodian well-versed in real estate investing. That ensures your account stays qualified per IRS rules and regulations and your investment is made without a hitch.
Jeremy Byars
Jeremy Byars joined Kingdom Trust in 2014. He is the senior vice president of communications and education. Byars is responsible for leading all internal and external communications and education. Additionally, he is responsible for process analysis and documentation, new employee training and orientation, technology integration, web content, document management and special project management. Kingdom Trust is an independent qualified custodian for the assets of clients of registered investment advisers, broker-dealers and investment sponsors, as well as their IRAs, non- qualified plans and qualified defined contribution 401(k) plans.
