A Self-Directed IRA—The Only Way To Own Real Estate With Qualified Retirement Funds

Let’s dive into the rules and mechanics of Self-Directed Individual Retirement Account (SDIRA), specifically in regard to investing in real estate.

An SDIRA is a trust. As such, you must use an approved trustee to set up and manage your SDIRA. The trustee must be a bank, a federally insured credit union or an entity approved by the IRS to act as custodian.

To maintain status as a qualified retirement account, there are really two broad rules:

1.    You cannot transact with “disqualified persons” such as yourself, certain family members and key persons in a company-owned business.

2.    You cannot engage in “prohibited transactions” (as defined in IRC 4975(c)(1) and IRS Publication 590).

These broad rules were established to maintain that everything the IRA engages in is for the exclusive benefit of the retirement plan. In essence, it’s the plan—not you, personally—that benefits.

When you break down the rules into specifics, there are a few no-no’s:

·       You can’t transfer property you already own into your SDIRA. While you certainly view your primary residence as an investment, you can’t use qualified retirement funds to purchase properties that benefit you personally.

·       When you buy an investment property with your SDIRA, you personally cannot do any of the maintenance or rehab work yourself. While you make the decision about what needs doing and who does it, neither you nor any other prohibited individual can personally do any of the work.

·       Documents of ownership cannot be in your name, ever. All documents, from the initial offer you make to the closing legal title and settlement forms, are owned and titled in the name of your IRA—and signed by the custodian of your IRA.

·       You cannot purchase a property and rent it out to a relative—that would benefit you personally.

·       All transactions and contracts—whether they be hiring a handyman to repair a toilet or securing an alarm system with a monthly contract—are conducted in the name of your IRA, never your personal name nor secured with your personal credit.

·       You cannot receive rental income or pay expenses personally. All income and expenses are funneled directly into and out of your SDIRA.

·       You cannot be the real estate broker and receive a commission when your IRA purchases property.

·       You must pay and receive fair market value when conducting investment transactions.

This list isn’t exhaustive…and there are thousands of situations that would come up in which you need to exercise discernment. For example, your IRA can own acres of property designated for hunting, but you and your relatives cannot hunt on the property personally. That would benefit you, not your account. And if you allowed friends to hunt on the property, you would need to charge them fair market value for the service and this “rent” would be collected by your SDIRA.

Bottom-line: You need to make sure you understand the rules and follow them diligently. That’s because the consequence of breaking the rules is disqualification of the entire retirement account as of January 1 of the year the disqualifying transaction occurred. In other words, your entire account (not just the asset on which you broke the rules) is deemed “not qualified,” and the total is automatically distributed to you as taxable income. You may also incur hefty penalties (including a possible 20% “accuracy related” penalty fine) in addition to paying distribution taxes and the early withdrawal penalty if it applies.

Ruth Lyons
Ruth Lyons
REALTOR®
5850 Waterloo Road Suite 140 Columbia MD 21045