Real Estate Problems: Avoiding a Nuisance Property
Yes, you are allowed to own real estate in an IRA. Of course, not every IRA custodian will accommodate such an investment, but that doesn’t mean it is forbidden. If you want to own a beach house in your IRA, or a commercial building, or an apartment complex, you have every right to do so.
But tread carefully. Owning real estate in an IRA could create the possibility of a prohibited transaction. You cannot vacation at the beach house, and you can’t change a lightbulb at the apartment complex yourself. To keep an arm’s length distance, it is best to have all repairs, rentals and general upkeep handled by an independent third-party property manager. Any fees owed to the property manager must be paid by the IRA, as payment with personal funds would be a prohibited transaction.
The prohibited transaction rules can be complicated, and if violated, an IRA account owner will find himself in a world of hurt. (The entire IRA is deemed to be liquidated, the tax-qualified status is lost, and any tax and penalties will be due based on a full distribution of all IRA assets.) But prohibited transactions are not the only issues an IRA owner needs to be concerned with. Here are five general items to consider when an IRA owns real estate:
Creditor protection. It is suggested that real estate be purchased through an LLC within the IRA. If there is an accident at the property, an LLC can help shield the IRA owner.
Liquidity. A house is not a liquid asset. You can’t cut the porch off and take it as a distribution. When an IRA account owner has only real estate in his IRA, he better find some liquid assets to withdraw if he is subject to required minimum distributions (RMDs). Since IRA RMDs can be aggregated, one option is to take the RMD from another IRA with more liquidity.
Valuation. Speaking of RMDs – how are they calculated? The December 31 IRA balance is divided by a life expectancy factor. If an IRA holds real estate, it is up to the account owner to value that property and establish a legitimate 12/31 balance. It is recommended that an independent property appraiser be hired by the IRA account owner - and paid with IRA assets. The custodian will not assume this valuation responsibility.
Rollovers. Can an IRA owner take the house out of the IRA as a distribution and replace it with cash for the same value? No. The same property rule dictates that if you take out cash, you roll over cash. If you take out stock, you roll over stock. If you take out a house, you roll over that house. Be careful when moving real estate from one account to another.
Selling the property. A full cash sale is easy. But what if the property is sold and financed? Now there is a promissory note in the IRA. What is the value of that note? What if the property buyer stops paying? An entirely new set of questions have now been introduced.
Real estate is a perfectly acceptable investment within an IRA. But the regulations are strict. Proper account management is paramount. Be sure to know the rules and how to keep your IRA real estate asset from becoming a “nuisance property.”
Copyright © 2021, Ed Slott and Company, LLC Reprinted from The Slott Report, 09.01.21., with permission. Real Estate in an IRA – Avoiding a “Nuisance Property” | Ed Slott and Company, LLC (irahelp.com) Ed Slott and Company, LLC takes no responsibility for the current accuracy of this article.
