IRA Accounts With Real Estate Investments

First things first, to begin a real estate IRA, the investor should generally seek the competent advice of an expert. These experts normally charge a set-up fee plus a yearly maintenance fee. The maintenance fee is usually tied to the value of the assets held in the account. Other administrators may use fee-based billing, wherein the account is charged for each transaction that occurs. Some may charge a hybrid or combination of all different types.

Real estate investments in an IRA may come in the form of commercial property, rent houses, land and/or condominiums.

Here's how it works. The IRA owner locates the real property to be purchased, and then the IRA account custodian (who is hired by the IRA owner) buys the property in an arms-length transaction. The IRA owner or the owner’s relatives cannot reside in the property owned by the IRA or sell the property to the IRA as these are deemed as prohibited transactions by the IRS.

The same IRS code restrictions also prohibit IRA owners or family members from managing the property in their IRA’s. Therefore, a non-relative manager must be used to manage and oversee the real estate investment in an IRA.

To fund a real estate IRA, the investor can begin with existing assets in his or her IRA. He or she may transfer all or a portion of assets from another IRA, or do a rollover from a 401k, 403b or other qualified employer-sponsored retirement plan. The funds rolled over then may be used to purchase the real estate assets.

Advantages of owning real property in an IRA

Additional diversification may be achieved. Owning real estate in an IRA may give the account owner an additional asset class he or she may not have as an investable asset elsewhere.
The IRA owner can actually see or touch his or her real estate investments that sit inside of the account. Often, this is not the case with stocks or bonds.
Real estate has historically been considered a somewhat secure investment with decent returns. Obviously, this has not been the case in some parts of the country with the recent housing market crash. On the other hand, the latest real estate collapse has resulted in lower prices which may make this a good time to invest in real estate. This is a decision the investor must make relating to future prices of real estate.

Disadvantages of real estate held within an IRA

Whereas the favorable capital gains rate is applied to real estate outside of an IRA, ordinary income tax is applied to distributions eventually required from all IRA’s regardless of the investments therein. In other words, favorable tax treatment of the sale of real estate is negated when the real estate owned within an IRA account. This, in my opinion, is the single greatest disadvantage of owning specific real estate in an IRA.
Anytime an investor steps outside the normal accepted investing methods, careful research is required to ensure the best decisions are made. Fees may be high because of the unusual nature of the transactions, and the limited supply of IRA trustees that may be hired.
The prohibited transactions rules are complicated, and the penalties for breaking them may be quite large.
The usual relative tax advantages for real estate ownership - such as the deductibility of real estate taxes and interest - are not available to an IRA.
The real property custodied in an IRA needs to produce adequate cash flow, along with annual contributions, to pay operating costs on the property held in the IRA. Rent or other income generated by the property in the IRA must go directly into the IRA and not pass through the owner’s hands.
Property appraisals may be necessary every year after the IRA owner reaches age 70½. This may be necessary to determine the size of annual required minimum distributions. Also, in order to take required minimum distributions at 70½, it may be necessary to sell some of the property in the real estate IRA. This disadvantage may create tremendous inflexibility to the account owner.

IRA rules are complex even without the additional legal burden added by real estate investing. Real estate IRA’s make the legal and tax ramifications even greater. Real estate investments held within IRA’s may be worth the effort and time spent. However, discretion must be made from the very outset.