Can real estate be purchased and held in a pension

[bpenfold]

I have a client who is wanting to purchase a second home. He wants to make the purchase using his pension and holding the real estate as an asset of the pension. Is that allowed? Or is there anything like this allowed?

He is the plan sponsor of his company's retirement plan. He has a traditional with profit sharing, plus he has a cash balance plan as well.

Thank you in advance!

 

[jpod]

A plan can hold real estate.  A plan fiduciary engages in a prohibited transaction under ERISA and the IRC if the fiduciary causes plan assets to be used for the benefit of a party-in-interest/disqualified person or engages in a transaction with such person, such as allowing that person to use a home owned by the plan rent-free or even for a fair rent. 

[Lou S.]

Real estate can be purchased the devil is in the details and they can be tricky.

A 2nd home for the good doctor, err I mean client. is almost certainly going to run afoul of the prohibited transaction rules.

Don't forget your annual fair market appraisal, possible annual audit requirements if you are a small plan that no longer qualifies to waive the audit, and your increased bonding requirements.

Suggest your client consults with qualified ERISA counsel who deals with real estate transactions to make sure they know all the PROS and CONS of real estate investments in a qualified retirement plan and to make sure they are not running into a prohibited transaction and the plan will have enough liquidity to met all of its distribution needs.

 

[bpenfold]

If this is allowed -- then how do we go about processing this transaction? Withdraw the funds to purchase the home and then just list it as an asset of the plan?

Do we have to get the home appraised every year to update the asset in the plan?

 

[Larry Starr]

Bpenfold: It ISN'T allowed. Perhaps the two prior responses weren't clear enough.

What he wants to do is a prohibited transaction and not allowed.

Hopefully that is now crystal clear.

Larry.

[jpod]

So far all he said is that the client wants the plan to purchase the house; he did not say that the client would use it while it's held by the plan, so technically we don't KNOW that it is not allowed.  (The client may want to buy it now, even though he won't use it for many years, at which time he will take it as an in kind distribution from the plan.)

[Larry Starr]

1 minute ago, jpod said:

So far all he said is that the client wants the plan to purchase the house; he did not say that the client would use it while it's held by the plan, so technically we don't KNOW that it is not allowed.  (The client may want to buy it now, even though he won't use it for many years, at which time he will take it as an in kind distribution from the plan.)

He said this: I have a client who is wanting to purchase a second home.

He can clarify if he really meant a real estate investment, but a second home has always meant just that: a second place to live.  I will assume that until told otherwise.  I think we know the answer to this question, but the questioner is free to change it.  I'd be happy to make a side bet, btw! :-)

Larry.

[ESOP Guy]

I would suggest you search this board using words like "real estate" to get a good idea of all the practical problems this kind of investment can have.

Real estate has lead to many threads on problems over the years on this board.  

So can it be legal?  Sure

Has it caused lots of headaches and problem also?  Yup

 

[Larry Starr]

3 minutes ago, jpod said:

So far all he said is that the client wants the plan to purchase the house; he did not say that the client would use it while it's held by the plan, so technically we don't KNOW that it is not allowed.  (The client may want to buy it now, even though he won't use it for many years, at which time he will take it as an in kind distribution from the plan.)

And let's talk about in-kind distributions.  Assuming there are other participants, he would have to offer in-kind distributions to everyone!!!!!  A sure fire way to screw up the plan.  Not to mention the issues of valuation.  And, no one has even talked about the fact that you would have to pay cash for the property since debt financing producing unrelated business taxable income!  Enough reasons I think to (quoting a famous first lady) JUST SAY NO! :-)

[Lou S.]

I'm going to say Larry is almost certainly right in this case that this will in fact be a Prohibited Transaction, but Jpod is also correct that there is a slim possibility that this is proper investment of the plan.

bpenfold, if this is allowed, that being a very big if - the Plan need to be the registered, titled, deed owner. you can't simply take the money out of the plan, buy the place, and list the property on the balance sheet.

And yes you need an independent appraisal every year to determine fair market value.

there have been 2 replies while I was typing so sorry if this was covered.

 

 

[Lou S.]

And another thing to consider even if this is a proper transaction - if it's the Cash Balance Plan that holds the property - you can seriously mess up the minimum funding and/or maximum deductible rules if Cash Balance Plan is the one that owns an interest in the property if you fail to properly value it each year.

In short if the guy really is trying to buy a 2nd home with his retirement assets it's a big no no as Larry has correctly already pointed out twice now.

[Mr Bagwell]

Run like Forrest Gump!!

[jpod]

Is it a bad idea even if not a PT?  Yes, it is a terrible idea for a variety of administrative reasons.  Will it be a PT?  We don't know that yet.  Is there a problem with an in kind distribution down the road?  Not if this investment is important enough for the client to take steps to fix the problem when the time comes.  There is no need to amend the plan now to permit in kind distributions.  He can do it at the time he wants to take the property out in kind, which may coincide with the termination of the plan.  

[jpod]

For the benefit of bpenfold, if the client is allowed under the terms of the plan to take a distribution from the plan now, the client can take a cash distribution, roll it to a "self-directed" IRA with one of the trust companies that offers IRAs for non-traditional investments, and then use that cash to purchase the home.  Unless the home is rented out, and the concept doesn't make any sense unless it is, the IRA will need plenty of other cash to pay taxes and other costs of maintaining the home, year after year after year . . . .  That cash may come from annual cash contributions to the IRA, other assets in the IRA, or a combination thereof.  Of course, the same PT issues would apply as described above, and it is still a terrible idea because if the house appreciates in value the tax bill when it is distributed in kind out of the IRA will be that much larger.  

[jpod]

Larry, try not to hurt yourself patting yourself on the back.

[david rigby]

I like this statement made at the 2018 Enrolled Actuaries Meeting: "you can have land in your plan, or you can have me as your actuary, but you can't have both."

[shERPA]

On April 13, 2018 at 1:36 PM, david rigby said:

I like this statement made at the 2018 Enrolled Actuaries Meeting: "you can have land in your plan, or you can have me as your actuary, but you can't have both."

This quote was originally from Bob Schramm talking about life insurance in a plan, I heard him say it maybe 20 years ago.  I'd rather deal with real estate myself.  If it is a true investment, fine.  If the objective is to acquire a second home thru the plan, fuggeddabout it, as the PT rules and/or distribution and taxation options will eventually trip up the client. 

Re Larry's UBTI comment, doesn't the IRC 514 exception to acquisition indebtedness for real property often apply?

[Patricia Neal Jensen]

Do not do this.  It is a Prohibited Transaction.

[ERISAAPPLE]

Over the years I have had a lot of clients with real property in their qualified retirement plans.  Usually it was for DB plans, but I have seen a few DC plans have it.  I never saw it work out well in the DC plan context.  Then again, few plans would have come to me with real estate issues if it did work out well.  I have, of course, never seen any plan hold a participant's "second home," or any single residential dwelling for that matter regardless of whose home it was.  Obviously plans can hold land.  There are a lot of traps, and it generally works only if the land is part of a much, much larger diversified portfolio.  Obviously plans cannot own a participant's "second home."  In addition, any small to medium-sized plan that owns real property is practically begging for a DOL audit.