Real Estate in an IRA

[Lion]

Want to hear what you know or have heard about Self-Directed IRAs investing in Real Estate via an LLC. Client looking for the next big deal. Owns an expensive residence and another house. Can't deduct mortgage interest from a third property on his Schedule A, and earns too much to deduct losses currently on rental real estate. Pros and cons, gossip, why an LLC within an IRA, etc. I think he thinks he can truly do it himself without a custodian and wants to own more real estate if he thinks it gives him tax advantages. Thanx for any and all info.

[Armando Beaujolais]

Want to hear what you know or have heard about Self-Directed IRAs investing in Real Estate via an LLC. Client looking for the next big deal. Owns an expensive residence and another house. Can't deduct mortgage interest from a third property on his Schedule A, and earns too much to deduct losses currently on rental real estate. Pros and cons, gossip, why an LLC within an IRA, etc. I think he thinks he can truly do it himself without a custodian and wants to own more real estate if he thinks it gives him tax advantages. Thanx for any and all info.

I've had a couple of clients recently tell me about hearing something on the radio saying to put your house into your IRA, etc. It sounds too good to be true.

Unfortunately, I think it is too good to be true.

This issue has been kicked around on this board and others before, and I've never seen anyone show a legitimate means of putting a personal residence into an IRA, especially without a custodian.

It is aggravating though. Your clients hear somebody on the radio saying things that sound great, then you're on the defensive having to justify your position to your client because your news is worse and they really want you to be wrong from the start.

[Bees Knees]

Yes, an IRA can invest in real estate. But you still need a trustee. The IRA owner cannot be the trustee. That is probably one of the biggest problems, finding a trustee that would agree to hold real estate for an IRA.

Another problem is the IRA owner cannot use the IRA assets personally. If he is trying to get his third house into an IRA, he can't live there, visit, or probably even drive by it without running the risk of creating a prohibited transaction.

[abby]

getting the real estate into the IRA

Unless the IRA has enough cash to purchase the third house, or at least make a downpayment, then I don't see how to get it into the IRA in any case. He can't contribute the property - the IRA would have to purchase it.

Custodians have different rules about managing the property - in many cases they are not willing to play property manager, and that definitely needs to be a third party. That job can entail making mortgage payments, paying taxes to actual property management if it is used as a rental.

It is very easy to disqualify the IRA if all those necessary activities are improperly handled.

[taxfun]

Real estate IRA's

OBSERVATIONS ON REAL ESTATE AS AN IRA INVESTMENT

It is questionable whether investment in real estate is a good idea or not. In general, if one wished to invest in real estate, a Roth IRA seems to be the preferred vehicle. Typically tax and financial professionals will suggest REITs as less troublesome and dangerous alternatives.

You must find a trustee who will allow a self directed IRA. There are very few institutions that handle such transactions.

Investments in real estate IRA’s must be in cash. Some advisors say that you could use your IRA money for a down payment and then mortgage the rest. They claim that you can get a mortgage – then the tax deferral applies only to the portion of the IRA that paid the cash; however, we are not proponents of this method of buying. Incidentally, a mortgage, if you could get one would have to be a “non-recourse” loan (might be next to impossible to get).

When your IRA funds are withdrawn, taxes will be “ordinary” vs capital gain as is typical with real estate investments. (IRA withdrawals and distributions are always “ordinary” income). If you have used a Roth IRA as a vehicle, distributions would not be taxable, so using a Roth IRA seems to be the best way to go. If you have all your IRA assets in a traditional IRA, you would have to convert to a Roth. Currently, if your income is more than $100,000 you can not convert.

There are numerous restrictions, including self-dealing. You cannot sell property to your IRA and you cannot invest in property that you (of related parties) might live in or be housed in (as in the case of a business or entity that you own or a vacation home) in the present to future.

There are numerous other “prohibited transactions” that one must watch out for. Being involved in such a transaction could trigger the distribution of the entire IRA.

Costs are higher for account management.

Assets invested in real estate are ill-liquid, thereby causing potential problems when Minimum Distributions and if are required. Also if the IRA account needs cash (as an example to make repairs to a rental) you cannot infuse money from your personal account. That would be a prohibited transaction and would result in the premature distribution of your IRA! Borrowing could also be a prohibited transaction, even if you could get a lender to loan to an IRA (which is doubtful). An IRA cannot be used a collateral for a loan - a prohibited transaction!

You cannot manage the properties invested in your IRA yourself. The Trustee or independent property manager, paid from the IRA would be required. What if you have a major vacancy? Shortages must be made up from the IRA and cannot be paid by the IRA holder personally. You cannot take advantage of normal depreciation or deductions for real estate taxes on real estate if it is in an IRA.

Some advisors favor having an IRA invested in a partnership or LLC that owns real estate as a way to escape some of the pitfalls.

In some cases a real estate invested in an IRA might trigger UBIT, (Unrelated Business Income Tax) taxable at trust rates that could be as high was 48%. If you have a mortgage, a part of the rental income and eventual gain from sale could be subject to UBIT.

[Lion]

Thank you

Thank you to everyone for all your comments. You've helped me list my concerns. He does have a lot invested in his IRA and a large 401(k) from a former employer he's going to roll over, so his IRA could probably afford property in Fairfield County, CT, with cash left over to cover his bills. He realizes he can't put additional into the IRA other than each year's maximum contribution. He's young enough that he's not thinking about RMD, even though he should be planning ahead to liquidate. He makes too much to convert his IRA to a Roth at this time. He does have the LLC idea from somewhere -- someone knew that IRAs holding real estate had been on the radio and another read a WSJ article, so who knows where my client got it. He is always looking for the next big deal. (His last was an LLC in Delaware that held his boat, so he could get tax deductions passed through his K-1 when he didn't qualify to deduct mortgage interest on a third "home." He's sold the boat.) Just hope to keep him away from any prohibited transactions and maybe even from those not yet scrutinized by the IRS but that will be if the press keeps giving them free publicity!

[Lion]

Ira

Well, he's moved on and looking for a new idea!

He was going to need financing and discovered that's a major hurdle within an IRA. (Probably discovered he can't get a current tax deduction for mortgage interest within an IRA....)

Thank you to everyone -- especially TaxFun who was generously thorough -- for lots of good comments so I had my thoughts straight before I returned his call.