Our client has land owned in his name. He plans to build a spec house on it. He wants to fund the construction within his IRA and then sell the house upon completion and keep the proceeds in his IRA.
Is there any prohibition against him owning the land the house will be on?
It would be great to get the land into the IRA but I don’t see a way to do that.
Any thoughts on how to evaluate the firms that host self-directed IRAs?
Thanks, Leslie
This is a ledge I routinely have to talk clients off of. Let’s take a quick look at the problems you’ll almost certainly run into down the road: 1) if you ever need to put money into the property (repairs, maintenance, upgrades, etc…) it has be done from the IRA. That means either burning off whatever cash you still have in the IRA, or making a contribution or rollover. What if neither of those are an option? Contributions require earned income and a rollover requires that you actually have money in some other qualified plan. 2) RMDs – upon reaching age 72, the account owner is obligated to take a minimum distribution from his/her IRA. What are ya gonna do: break off a corner of your house to distribute? Or, more realistically, be forced to deed a small portion of the property out of the IRA each year? You’ll pay far more in legal and deed recording fees over the years than you ever deferred (not saved) in taxes. The only viable plan is to have other qualified money somewhere to draw from and hope that it doesn’t run out. If the house is eventually inherited, the problem likely becomes even worse under the new 10-year distribution rules. Your heirs will most likely distribute the entire thing shortly after your death, pushing all of the taxes onto them (in one year) 3) tax deductions – many people take tax deductions for property taxes and mortgage interest paid (even if not on Fed due to TCJA, likely still at the State level). Not an option in an IRA. They become investment expenses that simply reduce your IRA balance. 4) IRA distributions are taxed at ordinary income rates versus capital gains. So when you do eventually distribute the house, either by RMD, personal choice, or inheritance, you’ll likely pay a higher tax rate. You’ll also lose the ability to take a section 121 exclusion (first $250k tax free; $500k for married couples) since you didn’t actually own the home. 5) IRAs also don’t get a step-up in basis. Under normal conditions, if you hold the house until your death, a step-up in basis would make the asset completely tax free to your heirs. Not so if it’s in an IRA. 6) There are multiple protections in place that allow you to maintain a primary residence while still qualifying for medicaid (e.g. nursing home) or bankruptcy. Not the case when your house is not owned by you, but rather your IRA. 7) prohibited transactions (as mentioned above) are a common minefield. Self-dealing doesn’t only prohibit you from selling the property to your own IRA, it also prohibits you from living in (or even leasing) that property. Real estate in an IRA is almost always a terrible idea, but if it is to have even the slightest chance of success, it really needs to be commercial or residential rental property that you do not otherwise use (personally) in any way whatsoever. 8) The IRS requires that an IRA’s assets be valued fairly and reported annually on Form 5498. For individual real estate holdings, this becomes a major problem. Can you simply report the tax appraisal each year and get away with it? Maybe. But to truly follow the regulations, you really need a professional appraisal done EVERY December to fairly value the property. Again, that ongoing cost will quickly outweigh whatever tax benefits you aimed to achieve. Bottom line: Real estate is an IRA is almost always a plan that is either A) pitched by the IRA custodians seeking to profit from this horrible plan, or B) cooked up by “tax gamers” that spend an unhealthy amount of time looking for ways to outsmart the system. There’s an old rule of thumb in the tax world: “For every loophole that you’ve spent an hour thinking up, the IRS has spent thousands of hours making sure you can’t exploit it. Or they are actively working on it”.
Permalink Submitted by Alan - IRA critic on Sun, 2020-10-11 21:17
Client cannot have his SD IRA purchase the lot from himself. That is self dealing and the easiest “prohibited transaction” to spot. Therefore, there is no easy way to get this lot into his IRA. Perhaps one of the SD IRA major players has a suggestion for this situation. Large SD IRA custodian are Entrust and Guidant, but there are several others as well. Best to stick with SD custodians who specialize in real estate investments. They can help an IRA steer away from prohibited transactions. Note that the IRS now requires custodian to indicate the type of holdings in the IRA on the annual 5498 form, so the IRS will know which IRAs are invested directly in real estate.