I just scrapped the blog I was writing because of a phone call I received. The call was from a man that I met on the east coast while teaching an event a couple of months ago. When I met him he was winding down on an audit that he was going through regarding some real estate transactions done in his Self Directed IRA. He called today to let me know how the audit had shaped up. Unfortunately the audit didn’t go well. His IRA had been disqualified because his custodian had permitted a prohibited transaction in the IRA.
As real estate investors we are familiar with the Latin phrase caveat emptor which is translated as buyer beware. Typically, as investors we think of this phrase in terms of making sure we have done our due diligence prior to acquiring an investment. However, this term must be applied when you are seeking out custodians for your Self Directed IRAs. Please don’t get me wrong, I strongly advocate the use of real estate transactions in retirement plans as a way to increase your retirement nest egg. Unfortunately there have been many unqualified groups pop up over the last several years to jump on the band wagon and cash in on the investors that wish to use retirement funds to acquire real estate, and if you fail to do your due diligence and to properly plan to follow all of the rules for investing in retirement plans you are truly planning to fail.
They Want Your Business
If you go to any search engine on the web and type in “IRA Real Estate” you will truly be amazed at the number of hits. I just found 621,000. The problem is that not all of these groups have your best interest at heart. They may promote strategies that are either blatantly prohibited transactions in an IRA or the transaction walks a very fine line. This is a slippery slope that you want to avoid.
IRS “Dirty Dozen”
For the third year in a row, Abusive Retirement Plans have made the” Dirty Dozen” List published by the IRS. The “Dirty Dozen” is a list of tax scams that the IRS annually publishes. If a taxpayer is found to be involved in one of these transactions not only does the taxpayer, innocent or not, face civil penalties there is also the threat of criminal prosecution. At the very least, you will be sure to have your IRA disqualified resulting in potential adverse tax consequences.
One transaction that the IRS is looking very hard at is when IRAs use limited liability companies to engage in activities that are otherwise considered prohibited. I am not saying that you can’t do many of the transactions Self Directed IRA custodian’s promote but just as no one will look after your retirement funds better than you, it is completely dependent on you, at least in the eyes of the IRS, not to engage in prohibited transactions in your IRA.
Before you jump into a business relationship with an IRA custodian follow a few simple guidelines:
- Familiarize yourself with IRS Publication 590 (http://www.irs.gov/pub/irs-pdf/p590.pdf)
- Confirm that your custodian is a licensed non-bank custodian.
- Confirm length of time the custodian has been in business.
- Is the custodian licensed to do business in the state you wish the IRA to invest in real estate?
- Find out the value of the custodian’s liability policy.
- Ask for past financial statements from your custodian.
- Check with the Attorney General in the state the custodian is listed to determine whether or not any complaints have been filed against the custodian.
Taking control of your IRA and using your funds to invest in real estate is an excellent opportunity. Just as you wouldn’t jump into an investment without doing your research do not blindly assume that everything you are told by a potential custodian that has a financial interest in having you sign up with them is true. Caveat emptor.
Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.