Self-Directed IRA (Rental Property)

[JohnH]

Taxpayers' daughter & her husband want to buy a new home. Problem is, they can't sell their old starter home in this market. Her parents are planning to buy the old home and convert it to a rental. (not renting to family members or related parties, just a plain old rental house).

The parents want to know if they can use a self-directed IRA to buy the old home from the daughter & SIL. I know they can't own it in the IRA if a family member lives in it, but does that restriciton apply to buying it from a family member as well? Would the simple act of purchasing the property (at fair market value) from the lineal decendant constitute a prohbited transaction?

[WhiteOleander]

I don't have alot of info on this idea. I have seen articles that the IRS takes a very dim view of an IRA holding real estate. The consensus was that it was difficult to find an administrator to run the IRA. The IRA would have to file a tax return and be responsible for paying taxes, repair bills, etc. That's more than most want to get involved with.

One article said that the owner of the IRA better never even drive by the property. The owner should have no connection whatsoever to the property. Otherwise the IRS will consider the whole thing a prohibited transaction. So, since this is a self directed IRA and the property was purchased from a relative, I don't think the IRS would say this is okay.

Sorry I don't have any cite to give you. This is along the lines of "my barber's postman's dog groomer said".

[JohnH]

Thanks for your thoughts.
I have much more confidence in your opinion that in any barber, postman, or dog groomer.

[BOB W]

I thought whatever happens in an IRA stays in an IRA until monies are distributed..?? Why would a tax return have to be filed for the rental issue?

[SFBOB]

Quidant Financial 1-888-4455

I just googled Self Directed IRA's. I called and talked to them and the answer was the parents could not purchase the house from a family member. This firm is located in Seattle Washington and seem willing to discuss the situation if your cleint wishes to phone. Maybe daugter could trandfer the property as a gift to another party and have the parents purchase form the third party. Just a thought. Good Luck Bob

[SFBOB]

Sorry the phone number is

Quidant Financial 1-888-472-4455

[JohnH]

I appreciate all the input. Bob, thanks for that lead. I think I'll call them when I get back from the Easter break & ask for their thoughts.

[Edsel]

IRA Administrators

The consensus was that it was difficult to find an administrator to run the IRA. The IRA would have to file a tax return and be responsible for paying taxes, repair bills, etc. That's more than most want to get involved with.

Yes, when you get away from cash, no one seems to want to handle it. Especially an independent party. No shortage of finding IRA Administrators to babysit your cash, though. Three cheers for the good job they are doing -- failing to make RMDs, triple the fees of a conventional brokerage account, messing up 1099-Rs, skimming off the top of mutual funds, etc. Hard to do all this stuff with a piece of real estate.

Oleander, you should feel gratified that John considers you more knowledgeable than your barbers' postman's pet groomer. Don't be intimidated by being placed on such a high pedestal...

[WhiteOleander]

I thought whatever happens in an IRA stays in an IRA until monies are distributed..?? Why would a tax return have to be filed for the rental issue?

Bob, the IRA would have to file the tax return as "UBI" unrealted business income. It has to report the rental income and deductions and perhaps even eventually the sale of the property. Otherwise, the IRA would accumulate gross rent income with no tax paid on it. The IRS sees this as tax evasion.

So, if the IRA purchased the property and just held it until it appreciated and then sold it, it would not be as difficult as receiving income on the property. It would be similar to the IRA buying stock and later selling at a gain. But, since the property creates income as it goes along, the IRA has to account for that just as an individual would.

[Bees Knees]

But, since the property creates income as it goes along, the IRA has to account for that just as an individual would.

Just a slight clarification. IRAs can make money and not pay tax (interest, dividends, capital gains, etc). Unrelated Business Income tax applies to making money as a trade or business. A tax-exempt entity, such as a charity or an IRA has to pay income tax when it earns unrelated business income. The idea is that a tax-exempt entity would have an unfair competitive advantage over a tax paying business if the tax-exempt entity could earn trade or business income without paying tax on it.

The question I have for rental property is whether or not rental real estate falls into the category of trade or business income for purposes of the UBI rules, or whether it is considered investment income not subject to UBI tax. I would suggest looking that up before considering whether or not UBI is a deterrent to putting real estate into an IRA.

Regardless of whether it is or not subject to UBI tax, holding real estate in an IRA is something not many IRA trustees would be willing to do. That is the key – finding an IRA trustee willing to do it.

[BOB W]

I found this very interesting, especially in others areas not related to to rental issues.

"Real estate rental income generally is exempt from UBTI, but becomes UBTI if the amount of rent is computed as a percentage of the tenant's profits."

Seems like it relates to Commercial Property for UBTI but not for residential property.

http://www.investorsinsight.com/blogs/retirement_watch/archive/2009/04/03/dos-and-don-ts-of-ira-investing.aspx

[DaveO]

Another problem is the fact only cash can be contributed to the IRA. This means all the money to purchase the property must be in the IRA already otherwise non-recourse financing would be necessary.

[Burke]

And that is the BIG deterrent for holding real estate in the IRA. The IRA account must purchase the real estate with its own funds and pay cash for it. If it borrows the money, its a prohibited transaction and disqualifies the IRA.

[WhiteOleander]

Another thought. If all the liguid assests of the IRA are used to purchase the house, what will the owner use for RMDs if they become necessary?

[JG EA]

Another thought. If all the liguid assests of the IRA are used to purchase the house, what will the owner use for RMDs if they become necessary?

Right! They would have to liquidate.