Can self-directed IRA buy/sell real estate?

Question

If so, I assume all cash flow (in & out...that is, income and expenses) must come into and be paid out of the IRA account, yes?
Advantages/disadvantages?

Sophia Maler · Answer

Will there be any penalty if I cannot find a tenant for a year or two?
Can I sell the property and use the money from this transaction to buy another investment property?  If so - who can I sell the property to?

Michael Lauther · Answer

Sophia Maler Jon is correct however I have been advised that you can distribute property out of an IRA and pay the tax on the appraised value. then you can do anything you want with the property. Of course the tax can be substantial and there would be a penalty prior to age 59 1/2.

Sophia Maler · Answer

If I fail to lease it - is there any way to convert it to a primary residence? The situation I'm trying to avoid is to become homeless with a useless piece of rental property...

Sophia Maler · Answer

If my understanding is correct - such property cannot be leased to any of my family members or myself. So if I fail to rent it - is there any way to convert it into a primary residence later?

Jon Holdman · Answer

To yourself?  Absolutely not.  You can't live it in or work on it.  To your mom, dad, son or daughter?  Nope.  To your brother?  Yep.

Jenny F. · Answer

I was wondering about that myself.

WOW! Wheatie!  Thanks for the info!

My financial planner suggested this very scenario to me last year but he didnt tell me all of that!!!  I am glad i didnt do it!  what is UBTI or UBIT?

Jon Holdman · Answer

UBTI is Unrelated Business Taxable Income
UBIT is Unrelated Business Income Tax
a related one is UDFI or Unrelated Debt Financed Income.

All these stem from the treatment of an IRA like a trust.  Effectively, an IRA is a "non profit trust" like a museum or University.  If a University runs a bookstore, and doesn't have to pay any tax, it could sell books cheaper than the regular bookstore owner.  So, UBIT comes into play to level the playing field.  At least, that's the justification for this that I've read.

UBTI is income from business that's unrelated to the primary purpose of the trust.  Now if you ask me, there's NOTHING that's unrelated to making my IRA grow, but, hey, they didn't let me write the rules.  There are a number of passive incomes, like interest, dividends, and rents, that are excluded.  But, any thing that falls under the UBTI umbrella is subject to tax.  The tax rate ratchets up very quickly to 35%.  That's your UBIT.

Then, in a fit of "except - except", items that are otherwise exempt become taxable if they result from debt financing.

None of that is to say you shouldn't own property in your IRA, or get a non-recourse loan to do it.  You just have to be aware of these numbers, and factor them into your evaluation.  After all, all the companies that make up the holdings in the mutual funds in your IRA or 401K pay taxes.

Jon

Jon Holdman · Answer

Yes, it can be done.  As you suspect, all money out must come from the IRA and all returns must go back to the IRA.  The upside is the normal IRA tax-free treatment.  So, any gains are tax free (Roth) or tax deferred (regular.)

There are some downsides.

You will have to find a custodian that allows it.  Fidelity or Vangard won't, but there are some who do.  They typically charge some fees for each transaction, as well as an annual fee.

Any debt must be non-recourse.  That typically means 30-35% down payment and a higher interest rate.

You cannot do any of the work yourself.  Any work you do is considered a contribution.

You must take care w.r.t. the "disqualified persons" and "prohibited transactions" rules.  You, your spouse, any of your ancestors or descendants, and specific other persons with whom you have a financial relationship are disqualified persons.  Any company where you are an officer or where you have 50% or more ownership is a disqualified person.  Your IRA cannot perform any transaction with a disqualified person.  So, your IRA can't buy from or sell to you or any other disqualified person.  Nor could you lease a rental to a disqualified person.

Certain income is taxable under the "unrelated business taxable income" rules.  The tax is UBIT - unrelated business income tax, and is applied at the trust rates.  Last I looked, the first $1000 is tax free, but anything over $10,000 ($10K, not $100K) is taxed at 35%.   Rents normally don't fall under these rules. However, rents from debt financed properties do, based on the fraction of the property that's debt financed.  The fraction is computed as debt divided by basis.  Since basis can decrease faster than debt (due to depreciation), the fraction can increase over time.

Any sort of active income, such as running a factory making widgets, is also subject to UBIT.  So, active investing, like flipping, would appear to be UBTI.

Jon