Be Aware of These Rules When Purchasing Real Estate with an IRA

Question: Most of my money is in my IRA account.  I found a good deal on a piece of real estate.  Can I buy the real estate in my IRA?

Answer: You can, but be careful.  The Tax Court recently agreed with the IRS after the IRS demanded taxes and penalties from a taxpayer who used IRA money to purchase land in Utah.  

The taxpayer had a self-directed IRA at Schwab.  He instructed Schwab to wire money from his IRA to a title company to purchase the land.  Schwab does not allow real estate in an IRA, so they issued the taxpayer a Form 1099-R that showed the amount of the withdrawal as taxable.  Taxpayer did not report it on his tax return, thinking it was not taxable because the land was purchased by the IRA.  Eventually the IRS caught up with the taxpayer and demanded income tax plus a 10% early withdrawal penalty plus a 20% accuracy-related penalty on the amount of the withdrawal.  Taxpayer took his plea to the Tax Court. The Court sided with the IRS.

Here are some guidelines to follow if you want to hold real estate in your IRA.

1) Find a Trust Company that specializes in IRAs that allow alternative assets such as real estate.  Most IRA custodians, like banks and brokerage firms, won’t allow you to purchase real estate in your IRA. Trust companies are easy to find if you search for them on the Internet.

2) You can’t “Have your cake and eat it too.”  If you own real estate in your IRA, you and your family members can’t use it.  You can’t live in it or use it as a vacation property.

3) You cannot buy the real estate yourself.  Your IRA must make the purchase and hold title to the property.  Every penny of purchase money, closing costs, and processing fees must come directly from the IRA account.  If you so much as pay the postage for mailing the documents out of your own pocket, you are breaking the rules.  Once the IRA owns the property, the same rules apply.  All money for improvements, property taxes, insurance, etc. must come from the IRA and not from your pocket.

4) If you plan to make a down payment with cash from your IRA account and finance the balance, your IRA must borrow the money, not you personally.  You cannot guarantee or co-sign the loan.  The loan must be non-recourse, meaning that if the IRA stops making the mortgage payments, the lender cannot lay claim to other IRA assets. 

It may be difficult to get a mortgage under these conditions.  If the IRA is successful at borrowing the money to make the purchase, all income from the leveraged portion of the property is taxable to the IRA at trust tax rates, which can be significantly higher than individual tax rates.

5) Your IRA cannot purchase real estate from a family member or an entity that you own.

6) When you sell real estate for a profit, at least some of the gain is usually taxed at more favorable capital gains rates.  But if an IRA sells real estate, all the gain is taxed at higher ordinary income tax rates upon withdrawal.   

Kenneth B. Petersen CFP®, EA, MBA, AIFA® is an investment manager and Principal of Monterey Private Wealth, Inc., a Wealth Management Firm in Monterey.   He welcomes questions that you may have concerning investing, taxes, retirement, or estate planning.  Send your questions to: Ken Petersen, 2340 Garden Road Suite 202, Monterey, CA  93940 or email them to ken@montereypw.com.