Question: I have a significant balance in my individual retirement account. Can I use my IRA to purchase real estate?
Answer: You can purchase real estate from your IRA. Various requirements must be satisfied to comply with IRA real estate purchases, however, and the failure to adhere to the requirements can be costly from a tax perspective.
You first must recognize that most IRA sponsors such as banks, brokerage companies and other conventional institutions that house retirement plan assets will not permit IRA owners to maintain assets that are not held in the institution itself. Typically, IRA sponsors generally only permit investments in cash, stocks, bonds, and other marketable securities. If you wish to hold assets other than conventional IRA investments, you must find an institution that allows alternative retirement plan investments. While there are institutions that permit real estate holdings, the annual fees payable to the IRA sponsor will likely be larger than you would pay to a conventional institution maintaining retirement plan assets.
Another concern with IRA real estate investments is the self-dealing rules which restrict transactions between IRAs and IRA owners. IRAs cannot buy or sell real estate from an IRA owner nor an IRA owner’s spouse, children, and other related parties, so-called disqualified persons. Likewise, IRAs cannot be lessors or lessees of real estate to disqualified persons. The self-dealing rules also prevent IRA owners and other disqualified persons from residing in the property for personal use. A violation of these rules can cause an IRA to forfeit its tax exempt status.
IRA owners who invest in real estate must observe the separation between the IRA and the IRA itself as far as expenses are concerned. All costs pertaining to the property, such as real estate taxes, insurance, repairs and maintenance and other expenses must be paid directly by the IRA. Real estate related expenses which are paid by an IRA owner could not only violate the self-dealing rules but also be recast by the IRS as a contribution to the IRA by its owner. IRA owners, while permitted to make contributions to their Individual Retirement Accounts, should be aware that the contribution limits are relatively small and may, by themselves, be insufficient to satisfy the ongoing cash needs for owning and maintaining IRA owned real estate. You might also note that the real estate expenses pertaining to IRA owned real estate cannot be deducted on the owner’s income tax returns.
Financing is also an issue with an IRA seeking to acquire real estate. If borrowed funds are needed to acquire or maintain IRA owned real estate, the loan must be made directly to the IRA. An IRA owner cannot borrow money and then loan the same to the IRA nor be a co-borrower on third party financing as the self-dealing rules will be violated. As a practical matter, there must be sufficient IRA assets to satisfy the loan payments as the lender cannot have any recourse against the IRA borrower. Moreover, in situations where an IRA does borrow money, other statutory provisions could impose income taxes on some of the income and gain from the IRA attributable to the real estate, even though the IRA is a tax exempt entity.
If you wish to reap the benefits of real estate ownership within your IRA, you might consider purchasing interests in one or more real estate investment trusts or perhaps some other marketable securities or investments whose business is real estate based. However, if you utilize the right IRA sponsor, you avoid the self-dealing rules and satisfy the applicable statutory requirements, you can purchase real estate with your IRA. Be aware of course that a significant decrease in the property value could seriously impair what many view as their most important investment, retirement plan assets. The bottom line is that you must be careful as you delve into IRA real estate ownership as the failure to satisfy the requirements could have significant tax costs.
The Tax Corner addresses various tax, estate, asset protection, and other business matters. Should you have any questions regarding the subject matter or if you have questions, you want answered, you may contact Bruce at (312) 648-2300 or send an e-mail to bruce.bell@sfbbg.com.
