How to Use an IRA Account for Real Estate Investment
To many people, the idea of diversifying retirement savings means investing in a mix of mutual funds. But others diversify their IRAs by making real estate a component of long-term retirement savings and investment. It may come as a surprise that you can place an investment property in an IRA, but you do need to find a custodian who allows it and who knows the compliance issues associated with maintaining real estate within an individual retirement account.
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Instructions
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Find a trustee company that can be the custodian of your account. Look for a company that has the infrastructure to maintain real property in an IRA account. Two examples of these types of trustee companies are Pensco Trust Company or Equity Trust, located in the Resource Section.
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Determine if you will be transferring an existing IRA or starting a new one with the trustee. If you have an existing self-directed IRA, you may have a balance ready to invest in real estate. Opening a new IRA with annual contribution limits, however, may limit some of your investment choices.
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Fill out the paperwork and submit it to the custodian company. If there is transfer paperwork necessary to move an existing IRA, expect that it may take up to eight weeks to move the assets. If you are already in the process of trying to close on an investment property, this may create a problem in escrow terms.
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Select the investment property, tax lien or property partnership that you are interested in placing into your IRA.
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Create a limited liability company (LLC) and obtain a mortgage to finance the purchase. Contact a lawyer if you are unsure how to create a partnership agreement with your LLC and your custodial IRA. However, if you are paying cash from the IRA account to buy the property (and don't need to borrow money), you will not need to create an LLC.
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Do not use the property for personal use or commingle personal funds in the property. You may not use this property for personal use, rent it to immediate family or use it for vacations; nor should you take your old dishwasher and put it in the rental property. These actions violate the Internal Revenue Service regulations regarding an IRA investment property. You can, however, have investment partners.
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Fill out the escrow paperwork with the IRA as the title owner of the paperwork.
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Account for all income and expenses on the property as if it were its own business. All income earned on the property, such as rent or capital gain, is considered appreciation on the investment. Therefore it is not considered a contribution nor is it considered as a capital gain when the property makes money. Costs associated with maintaining the property need to come from the IRA and are not able to be deducted.
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Fill out IRS Forms 5498 and 990T to comply with the IRS. Check with your tax adviser if you have any questions about an Unrelated Business Income Tax and Unrelated Debt Financed Income that may be associated with your purchase.
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Tips & Warnings
Smaller IRA values can still take advantage of real estate investing through tax lien purchases and partnerships. The IRA doesn't need to own the entire property and can be a partner with others.
If you pay your loan off 12 months prior to selling the property, there should be no Unrelated Business Income Tax to pay.
Placing real property in an IRA does not prevent all taxation on the asset but it will be leveraged by the benefits of the IRA. There is still property tax and the Unrelated Business Income Tax that may need to be paid.
