Mistakes Real Estate IRA Investors Make

Estimated reading time: 3 minutes

For investors who have the means, the time, and a custodian willing to handle one, real estate investments can be a great way to secure and grow funds for retirement. Most IRA accounts allow investors to choose from a variety of investments for where to place their retirement funds. Most choose to spread their wealth over a few options. Some are riskier with potential for a big pay-off, while others are safer with small growth potential. Real estate investments need a lot of time and attention afforded to them, so usually experienced investors who have extensive knowledge surrounding rental, flip, and/or new-build properties are the best candidates for investing in real estate.

Since real estate investments require more paperwork and detailed management than a typical investment, many investment groups don’t offer this option, or charge higher fees for their administration. Besides forgetting about additional fees that come with real estate investments, here are a few more mistakes real estate investors make:

  1. Renting to disqualified people. Many investors wonder if they can purchase a property with their IRA and use it for personal use or rent it to family. The answer is no on both accounts. Strict IRA Real Estate rules prohibit you or immediate family benefitting from or using the property in any way. This includes space to run a business, primary residence, or having connections to the rental company who operates on the property (such as an apartment complex).
  1. Putting personal equity into the property. Again, you must not benefit from the property in any way, other than at retirement. If you use personal funds for maintenance costs, the value will increase, and your investment will increase without any deductions. The same goes for “sweat equity”, or time you devote to repairing projects yourself. All maintenance costs, bills, taxes, and other fees must be paid for with your IRA money.
  1. Personally benefitting from profits. Just like you can’t put personal equity into the property, you can’t directly profit from the property either. For instance, you can’t take personal checks for rent payable to you. All generated income must be paid to the IRA itself. All profits and gains from the property are assessed when you take a deduction on your IRA or when you decide to transfer funds into another investment.
  1. Improperly filling out paperwork. Like other investments, real estate investments are made in the name of your IRA, not you. When filling out paperwork involving the property, transferring money, and accepting profits, you must always list actions as performed by your IRA.

Liquidating upon retirement. You won’t be required to sell any of your IRA investments upon retirement. Even traditional IRAs, which require minimum distributions once you reach 72, don’t force you to sell all of your investments in fulfilling this obligation. If the real estate market is in a down swing, you may want to wait until the value increases again before using the profits for your retirement. Remember to discuss all transactions with your financial planner before taking action.

Real Estate IRA Rules

Estimated reading time: 3 minutes

If you haven’t been too fond of how your IRA is doing with stocks or bonds, you’ll want to take a look into putting your IRA funds towards real estate. Any type of real estate can be purchased with an IRA. Although you can invest your IRA towards real estate, there are many rules you have to follow for how you can buy real estate with your IRA and how you can use your real estate. If you violate these rules, you will face serious consequences with your taxes.

Self-Directed IRA

IRS rules do not set a requirement for forcing real estate as an option towards investment, even though the rules of the IRS do allow IRA funds to be used towards a real estate investment. Most companies that offer traditional IRA investments will not allow an IRA owner to make an investment in real estate. This is because there is a burden on administration for the management of real estate investments. If you are in this position and want to invest IRA funds in real estate, you will be put into a position where you have to convert some or all of your traditional IRA funds to a self-directed IRA. A self-directed IRA is a type of IRA that allows you and you alone to make decisions on your investments. These can be created at banks that are non-depository.

Transactions that are prohibited

Based on the rules of the IRS, real estate that is owned by an IRA can only used for investment purposes. Because of this, several restrictions have been placed that change the way you can manage your real estate investment. One of the most important terms when trying to understand the restrictions is “disqualified persons”. This is talking about the person who owns the IRA and the people close to them. Disqualified persons would be advisers and someone in a business who has interest that is greater than 50 percent. Purchase from a person who is considered disqualified is against the IRS rules, and it prevents them from using any real estate that has been purchased with an IRA for self-gain.

Issues with financing

Using cash for your investment will allow a future payment for the property to stay in the IRA, which is tax deferred until distributions are ready to be taken out. However, if you get any sort of mortgage out of it, you will be required to pay taxes. You will won’t have a guarantee that you will get a portion of the mortgage back.

Tax Consequences

Violating the rules of the IRS regarding restricted transactions will allow the IRS to take the funds that you used in your IRAs distribution. You will be required to pay taxes on funds that are from the first year in which the payment has taken place, and you will also be charged interest. Additional penalties could be included, depending on the situation. It is best to follow the rules and always talk to an advisor before moving funds to avoid accidental penalty.