BiggerPockets

Real Estate Investors Beware Of These Ira Tax Traps!

It seems that everywhere you look somebody is telling you to set up a self directed IRA and invest in real estate. So you may be wondering is this a wise thing for you to do? The answers to that are both yes and maybe not.

Yes, you can use your IRA and draw upon your experience as a real estate investor to build a large amount of money inside your IRA for your retirement.

Maybe not, because the restrictive rules governing your IRA create a minefield of tax traps and one misstep can disqualify your IRA causing you to have to pay all of the taxes, interest and penalties due.

Here are just a few of the tax traps to consider before using your IRA…

1. You cannot invest your IRA into the same property as a related party has invested their IRA. This runs afoul of the "related party" rule that prohibits you from doing business with your spouse, son, daughter, mother or father.

2. As the IRA owner you cannot use any asset of the IRA for your personal benefit. So that vacation condo your IRA purchased and rents out, you can't stay in it in the off season.

3. You cannot use IRA money to help you acquire a property. Such as using a big chunk of the IRA as a down payment to help you get a better loan.

4. Your IRA needs to obtain a mortgage to acquire a property. That's no problem as long as it is a non-recourse loan. The definition of non-recourse would be that the mortgage company cannot look to you or your assets to guarantee the loan in anyway. The property is the sole and exclusive collateral.

5. Your IRA rental property has been vacant for a while and your IRA is out of money to pay the mortgage and insurance, etc. You cannot pay any of the IRAs expenses out of your own pocket. Either you add a contribution to your IRA (if you're not maxed out) or the IRA will have to borrow some money from some where? (Oops, not a related party).

6. Here is a nasty tax surprise…selling an IRA property with an existing mortgage creates Debt Financed Income (DFI) which triggers profit robbing tax called Unrelated Business Income Tax (UBIT) How bad is it? On $9,750 profit from the sale of the property the tax is 35% - OUCH!

Now don't be discouraged using your retirement funds to invest in real estate is a great idea. Its just your IRA is not real estate friendly, the solution is to rollover your IRA to a better more flexible plan that does not have the same restrictions and heaven forbid penalties.

In conclusion, if you decide to go ahead and invest your IRA in real estate do so with a thorough understanding of the rules and always work with a specialist who can guide you these murky waters.

Comments