Real Estate in an IRA
Is it possible to use assets in an IRA to purchase real estate?
I’d expand on Alan’s comments and say that for rental real estate there are NO tax benefits. Rental real estate outside an IRA allows deductions for interest, property taxes, operating costs and depreciation against rental income. If you come up with a net loss, it will be deductible – although maybe not until the property is sold. When it’s sold, capital gains tax rates apply for the most part.
In an IRA, no expenses are tax deductible. If the IRA is cash poor and you pay some expenses on behalf of the IRA, that could be a prohibited transaction. If you put some money in to cover rental expenses, that could be an excess contribution – subject to an excise tax. If the rental is profitable and has a mortgage, some of the profits are subject to unrelated business income tax. In effect a double tax – the IRA pays a current tax and the owner is subject to tax on the same income when it’s withdrawn from the IRA. Also, if the property is sold at a profit, there’s no special tax treatment. The dollars are taxable as ordinary income when they’re withdrawn from the IRA.
So, traps that can disqualify the IRA and no tax benefits. It doesn’t seem like a good investment as far as I’m concerned.
I think many of the problems cited (e.g., annual valuations) would be mitigated or eliminated by using Roth IRA funds to buy real estate for rent. I’m 61 and have had a Roth IRA for 12 years (so I don’t face any new 5-year holding requirement on additional Roth funds I convert from the traditional IRAs into which I rolled over my 401k money last year). I plan to convert about $300K from IRAs to Roth (probably half late this year and the other half early in 2011, to limit bracket creep and thus the tax bills, which I’d pay from non-IRA savings). I’d then combine the converted funds with those in my original Roth IRA and use a specialized custodian to purchase the best single-family home I can afford as a Roth asset (ideally from a distressed seller, in a short sale or as a bank repo, to maximize value; I’m guessing there still should be plenty such opportunities in early 2011). I’d leave maybe $25K in cash in the Roth as a cushion against r.e. taxes and maintenance (though I’d only buy a property in verifiably good shape). Rental income would flow through the Roth IRA, and I could take any or all of it at any time as tax-free distributions. The ROI yield should be many multiples of the best interest rate I could get through MM or bonds. (I’m stock market averse and don’t want to tempt fate since I avoided any haircut in late ’08 by dint of having moved my then-401k savings in April ’08 to a “stable value” insurance-backed fund with no exposure to equities). When the housing market rebounds one day, my Roth IRA can sell the appreciated rental house for a tax-free capital gain that’d be icing on the cake of the tax-free rental income I’ll have enjoyed. The only hitch in all this is that I may have to pay $80K or more in taxes upfront on the Roth conversions, though that’d be the last income tax bill I’d ever pay (other than the small tabs for future Soc. Sec. and interest income on non-IRA savings).
-Rich
Permalink Submitted by Alan Spross on Thu, 2010-03-25 20:33
Yes, but there are alot of pitfalls to consider. The real estate cannot be used in any way by the IRA owner or their family or a prohibited transaction occurs. There must be enough liquid assets in the IRA to totally service the property including RE taxes, maintenance, insurance etc. There may be a need for frequent appraisals at IRA expense in order to determine year end IRA values. For rental real estate, many of the tax benefits are lost if the property is held in an IRA.