Use 401K/IRA for a real estate purchase?

Question

Hello. I am looking to buy land (not for primary residence) and I heard that you can use a 401K or IRA (or similar) to purchase real estate, or else loan yourself money from the 401K, or something to that effect. Is this a suitable method for investing in land (long term investment)?
          
          If not, are there better ways to raise the cash for this type of thing, or is a land loan just the way to go? Please let me know. Thanks.

Jon Holdman · Answer

Interview multiple tax guys to find one that has an understanding of the IRA real estate rules.  Ask "tell me the circumstances where UBIT would be due".  Don't elaborate on what UBIT means, just use the acronym.  If you get a blank state, they're not for you.

Not to derail the discussion, but the tax benefits of RE investing are way over stated.  Realistically, the deductions will shelter the rental income.  Good deals don't produce much, if any, passive loss.  Crummy deals, like the ones you see on the MLS with the note "this cash flows!!!" do.  Your ability to deduct this is very limited.  Only if your AGI is under $100K, phased out completely at $150K.  Limited to $25K so it only works for a few properties.  The real kicker is you have to pay it back.  When you sell a rental, the amount of gain up to the depreciation taken or that could have been taken if not taken is subject to "depreciation recapture tax", which currently maxes out at 25%.  Recall also depreciation reduces the basis for your property, creating a correspondingly larger gain when you sell.

Passive losses are gravy you may get if you own rentals, they're hardly a reason to invest.  I'll go further to say if your AGI is under $100K, and you have a rental that's generating big passive losses (i.e., its a crummy rental thats costing you money out of pocket), you really shouldn't be in the rental property business.

The best way to use IRA money for rentals is to pay all cash.  But then if you realistically evaluate the expenses (see the 50% rule discussions in the rental property forum), you may find the return is too low for your liking.  I do this calculation about every six months, hoping to see a way to make it work.  It never does.  Part of the power of real estate is leverage.  By using debt, you get the gain for yourself.  Even a small increase in rents or property value can give you a nice return.  Without the leverage, it just doesn't give as good a return.

Personally, I find doing hard money loans with IRA money to be easier and more profitable.  No issues of accidental contributions because you did work on your property (you cannot do any work yourself on a property your IRA owns because that would be considered a contribtution.)  No UBIT issues because its an investments that's exempt from UBIT.

Account Closed · Answer

About the biggest downside is the loss of the write-off of passive losses, usually caused by depreciation and one of the main advantages of rentals when not primary job, reduce your taxable income.

If a rental has a loss for the year including depreciation, which is very common in rentals, you can write off that loss versus other passive income ( investment gains, interest income) and lower your taxes, up to a limit.

This paper loss vs real income will be lost as you don't pay taxes on gains in IRA or 401k and cannot write-off the IRA loss versus non-IRA income.

With prices the way they are, low, and expected capital gains due to the unusually low prices of houses at the moment, not a killer point, but one to be aware of.

Speak to your tax guy about the rules for a full view of the affects.

Cheers.

Jon Holdman · Answer

Yes, you can use IRA money to buy real estate.  You need an account with a trustee who will allow this.  Most, like Fidelity or Vangard, do not.  Sterling Trust, Equity Trust, and Guidant Financial are three who can set this up.

You absolutely cannot loan yourself money.  That's a "prohibited transaction".  If you do this, the IRS will declare that your entire IRA (the account from which you did the loan) is a distribution.  You will immediately owe taxes at your current rate plus a 10% penalty on the entire account, not just the loan amount.

Whether or not you can do it from a 401k depends on the rules set up by your company.  Unlikely this is allowed.

Even throuhg its in an IRA, certain investments may still be subject to the rather nasty "unrelated business income tax".  For example, if you bought the land, built houses on it, and then sold them, you would be subject to UBIT.  Rental income is not subject to UBIT as there no debt involved.

Eliezer Davidson · Answer

Your IRA can purchase real estate according to IRS regulation, but that doesn't mean your custodian will allow you to purchase real estate. Most custodians only allow you to by wall street products.

To purchase real estate with your IRA first find a custodian that would allow you to buy real estate with it. That would still be a pain as your custodian is the owner of the real estate and that means, that means every time you  collect rent you must send it to the custodian. In other words there will be lots of transactions which translates into lots of fees.

N.A N.A · Answer

The funds are currently in 401K's, which I plan to roll into self-directed IRA's. I don't plan to sell houses on it or try to make any money. Just buy it as a long term investment.

Are there any downsides to this practice?

Use 401K/IRA for a real estate purchase?

Most Popular Reply