Using your self-directed IRA to hold your rental real estate investments can be an excellent way of both sheltering the investment from taxes and funding your retirement. However, the IRS has many strict rules about self-directed IRA’s. Failure to follow these rules can result in major penalties and leave you with a huge tax bill. The most common danger is inadvertently executing one of the real estate IRA prohibited transactions.
Real estate IRA prohibited transactions mostly center around what the IRS calls “disqualified persons”. A “disqualified person” is simply someone the IRS doesn’t allow your self-directed IRA to have transactions with. The most common examples are you, the owner of the IRA, your spouse, immediate family members, and even grandchildren or great grandchildren. If you or an immediate family member will directly benefit from the investment property you wish to hold in your self-directed IRA, the property should not be purchased through an IRA. Two common examples:
• Holding a second home or vacation property within your self-directed IRA.
• Purchasing a piece of rental real estate for an immediate family member to live in.
In both circumstances, the IRA owner benefits by either using the property personally or profiting from the family member’s rent payments.
Types of Real Estate Prohibited Transactions
You cannot use real estate in your plan to secure a loan to you or any other of the “disqualified persons” discussed above. If you do so the IRS will consider the action an early distribution and tax the transaction with the early distribution penalties. You also cannot buy or sell property for the plan to or from any of the disqualified persons. While it is common in real estate investing to legitimately buy and sell properties with family members, you cannot do so with property in your self-directed IRA.
Rental real estate investing is an allowable use of a self-directed IRA. However, exercise caution that you are not using the rental for personal use. For example, renting to a disqualified person is a real estate prohibited transaction because it looks more like a personal use of the asset. Another rental real estate investing action that will cause problems if the property is held in a self-directed IRA is if you own a vacation home that you rent out to others, but you use it for personal use a significant amount of time.
The self-directed IRA is a powerful tool for rental real estate investors. If the rules are followed you will benefit from the traditional tax relief IRA’s offer, and you will be able to grow your investment. But, the IRS will closely examine any self-directed IRA for prohibited transactions, and will apply heavy penalties if it finds any violations. Always confer with your tax professional for your individual tax situation.
Contact Gene Mock, Associate Broker, Premier Team, Keller Williams Realty 703-342-8100 for professional real estate advice and guidance in the Northern Virginia region.
Gene Mock, “Realtor® of the Year 2014″ by the Dulles Area Association of Realtors®
Rental Real Estate Investing and IRA Prohibited Transactions