Purchaing real estate inside an IRA

[Archimage]

I had a client find this and was wanting to know more about it. Does anyone have any comments on this?

http://www.pottsfinancial.com/ira_articles.htm

[david rigby]

There have been several discussion threads here on this topic.

[Appleby]

It does not appear that the “outside the IRA and owned outright” concept was fully explained . Overall, there are many other issues to consider that were not even broached in the article. Similar to the “inside and owned by the IRA” concept, the “Investment restrictions, custodial fees, distribution rules and ultimately income taxes must be paid. All proceeds must go back into the IRA “ to which the article refers also applies to the “outside the IRA and owned outright” concept.

Anyway, these transactions can be quite iffy. One must be extremely cautious and ensure that self-dealing does not occur.

[Archimage]

I cannot find any threads that discuss the concept of owning real estate "outside the IRA". Would you mind posting a few links?

[imchipbrown]

Sometimes we're so inundated with the forest of regs that we can't see the trees of common sense.

I own my home (well the bank owns half of it). So I own it "outside of an IRA". My mother has two houses. They're owned outside an IRA. They're owned outside a 401(k) plan, defined benefit plan or SEP as well.; }

[Archimage]

I thought it may have referred to making the IRA a shareholder in a LLC or LLP used as a real estate investment entity.

[Appleby]

Chip---I think the IRA must be involved somehow .

Owning the assets in your IRA means holding it in your IRA as an investment, as you would with say stocks, mutual funds, bonds etc that are purchased in the IRA with the cash you contribute to the IRA.

Holding it outside of your IRA means you used assets from your IRA to investment in a real estate venture/deal. For instance, say I own land that I want to develop. I am short on funds and you agree to help by lending me money from your IRA. I give you a note or some other form or note, with the details of the agreement, such as interest repayment and when I will return the funds to you IRA in exchange for the note and under what conditions. The note is held in your IRA in place of the cash you loaned me. Only, this is not a loan per-se. Like Archimage said, it is making the IRA a shareholder

[mbozek]

Financial advisors who give advice on using RE for IRA investments are not the best advisors for complex tax rules. First there is UBIT on IRA assets used as collateral for a RE loan. Second the PT rules of IRC 4975 prevent a fiduciary (the IRA owner) from using IRA asset for his own personal benefit or selling,buying or leasing assets from or to the IRA. (There is also a case where the assets in an IRA were treated as distributed because the IRA owned a house in which the IRA owner lived.) Third owning RE in an IRA results in the loss of substantial tax benefits such as deductions for property taxes, maintence expenses, insurance, legal fees and depreciation and all distributions are taxed as ordinary income instead of capital gain. Also the IRA must be valued each year under IRS rules.

In addition there are substantial liability risks associated with owning RE such as for negligence or environmental violations. For this reason there are few custodians who will hold RE in an IRA and they charge substantial fees for acting as a custodian to pay for insurance.

Holding the RE outside of the IRA means that the IRA makes a loan to the RE owner and takes back a secured interest in the IRA such as a mortgage. Provided the PT rules are complied with, it is perfectly legal and the mortgage payments are tax deferred earnings which are added to the IRA assets. However the IRA bears default risk if the debtor stops payments and would have to incur legal expenses to recover the property and sell it to another buyer. The IRA would also not collect any income while the property is in forclosure. Finally the IRA is not eligible for capital gains when the property is sold by the owner.

I would not rely on any advisor who claims that an IRA owner could use an office in a building owned by his IRA or take a vacation in a residence that your IRA owns since the PT rules prohibt the IRA owner from using IRA assets for his personal benefit.

Note: There are exceptions to the PT rules where several owners including an IRA purchase an interest in RE through a limited partnership or other device but there are substantial legal/tax costs involved in complying with the PT rules which will have to paid by the IRA owner. The IRA will incur UBIT if the IRA owns an interest in property used as collateral for a loan.

The client needs to consult a tax/legal advisor to discuss an RE investment using IRA assets.