Living in your IRA owned real estate: Isn't that prohibited?

“I have an Individual Retirement Account invested in Real Estate. Now how do I take that real estate to live in, when I’m retired?”

That rental property has served your retirement plan well, not only appreciating in value over time, but most importantly providing regular monthly cash flows over a number of years, and seemingly promising to do so indefinitely.

But what if you’ve decided you really want to retire and live in that house? Since, after all, your IRA owns it!

When you know that your objective is to live in the property acquired by your IRA, the easiest way to accomplish this is to make the investment in your Roth IRA, to begin with - since once you’ve held the Roth IRA for 5 years and turned 59 ½, it’s yours, free and clear (no tax or penalties to withdraw).

Of course, wouldn’t you know it? Your real estate assets held in your Traditional IRA, however. So what are your options then?

Certainly, you can distribute the house once you’re 59 ½, without paying any premature withdrawal penalties. But you’ll have to pay taxes on the dollar amount (property value) of your withdrawal, as though that amount was some cash added to your income in the year you take it. Naturally, since we’re talking about thousands of dollars, this may be more costly to you than it’s worth.

Here are 3 options to help you get there:

1) Do you realize that you can distribute your IRA’s holdings a little bit at a time? For example, at age 59 ½, you could begin distributing 10% of the property from your IRA, each year.If you distributed 10% in year one of such a program, this would result in the property being owned 90% by your IRA, and now 10% share is owned by YOU. You’ll need to arrange with the title company so that the ownership share is properly reflected anew, each year. You’ll still be constrained from using the property personally until it is entirely divested from the IRA, and thus is fully in your name.

But this will have allowed you to spread the tax burden from distributions over a 10-year period, leaving you free to enjoy your retirement property, bought and paid for.

Moreover, this will change your monthly cash flows. You will personally be entitled to a direct 10% of income and responsible for 10% of expenses. These proportions would need to be honored since there are now two investors, you and your IRA.

2) You could consider converting a portion of your IRA (including that real estate asset) to a Roth IRA. Yes, you’ll pay income tax on the amount you convert, but this may make sense for you, if you anticipate a number of years more of income to sock away, and for your IRA’s value to grow, before reaching age 59 ½. The point here is you are paying some tax now on a smaller amount, instead of paying tax now on a much larger amount, down the road at retirement.

What is more, you could convert a fractional share from your IRA to a Roth IRA, each year, so that at some point in the future your Roth IRA owns the entire property. Then, if you’ve reached age 59 ½ with 5 years in that Roth IRA, it’s available to withdraw, free from penalty or tax.

3) You may even elect to begin distributing shares of your property even before retirement age, by electing to do so using the 72T method. The IRS grants the 72T method (‘substantially equal payments’) as an exception, which enables one to avoid the penalty for early IRA withdrawals.

YOU HAVE SOME WAYS TO STRATEGIZE!

The 72T exception offers a choice of methods, which you can use to tailor the timeline of your distributions. All are based on your life expectancy (or, if you elect, on the joint life expectancy of you and your beneficiary), and whichever method you choose must be continued for at least 5 years or until reaching age 59 1/2.

Your tax advisor can help you determine if one of these options makes sense for you. Best of Luck!