Realty investment inside an IRA requires finesse
BY TERRY SAVAGE Sun-Times Columnist Mar 18, 2007
Updated: May 3, 2013 12:14PM
What's in your Individual Retirement Account? It's a safe bet that you've invested in mutual funds, stocks, bonds and maybe even in a bank certificate of deposit or money market fund. But if you've built up substantial sums in your IRA -- either from wise investing or from rolling over 40l(k) plans from previous employers -- maybe it's time to graduate to some more sophisticated investments.
Federal laws restrict investments in life insurance and collectibles inside an IRA. You can buy gold bars, but you can't invest in collectible coins, with the exception of certain gold and silver Eagle U.S. coins. You can't buy artwork, gems, carpets, alcoholic beverages or stamps inside your IRA.
But you are allowed to buy investment real estate or shares in non-public companies, inside an IRA. Few people do that simply because of the perceived difficulty of finding an independent custodian to hold the property and value it each year.
That's the opportunity that some independent trust companies are stepping up to provide. The Entrust Group, one of the largest, has built a huge business since its founding in 1981, and now serves as administrator for more than $2.5 billion in "unusual" IRA assets. CEO and founder Hugh Bromma says the process is easier than most people imagine. But he warns that you must follow strict rules if you want to make real estate investments inside an IRA.
The most important rule is that your IRA investment cannot involve "self-dealing." That means you can't purchase a condo and "rent" it to your child who is a college student. In fact, if any member of your family is involved in the real estate transaction, either as a seller, buyer or user of the property, it is sure to raise a red flag with the IRS.
Dealing with real estate partnership investments or a cash real estate purchase is relatively easy. The independent administrator handles all the paperwork, and deals with the seller or developer, attorneys and title company. Before the deal closes, the client must read and approve all documents. Then the forms are signed by the custodian/trustee to make the purchase on behalf of the IRA. As custodian, the trust company is prohibited from making any money on the real estate deal itself.
If there's a mortgage involved in the purchase, it creates some tricky details. Since the IRA is the owner, the loans cannot have recourse to the individual who owns the IRA. And, of course, the IRA must be funded with enough cash to make the monthly mortgage payments and taxes and insurance, on the property titled in the IRA.
That's why most property purchased in an IRA is income-producing, although the IRA must have enough liquidity to pay monthly costs in case the property is not rented for a period of time.
There's another liquidity issue. Once the IRA owner reaches age 70½, he or she must start withdrawals. That's no problem if there is cash or liquid assets in another IRA, since the required minimum withdrawal can be made from any IRA. Still, the trustee must be able to value the property so the minimum can be calculated. In the absence of other liquid assets, all or a portion of the real estate in this IRA might have to be sold, perhaps in a difficult market.
Finally, if you're going to invest in real estate inside your IRA, do it only with a small portion of your funds, and in a separate account, so all your assets won't be penalized if the IRS disallows your real estate investment.
There are costs to setting up this type of IRA. Entrust charges a one-time $50 fee to open the account, plus a one-time charge of $95 for the purchase of property. There might also be fees for wire transfer of money to settle a real estate deal. Then there is an annual fee of $250 for each asset, regardless of value.
You can contact Entrust at www.TheEntrustGroup.com or call (888) 340-8977 to find your nearest local office. Other independent trustee companies include FiServ Trust Company, (800) 962-4238; Sterling Trust, (800) 955-3434, and Equity Trust, (888) 382-4727.
Buying alternative investments inside your Individual Retirement Account might be too complex for most people. But if you're willing to do your homework, and follow the rules on real estate investing in your IRA, the trust companies are ready to help. And that's The Savage Truth.
Terry Savage is a registered investment adviser. Check out Terry's answers to reader questions at suntimes.com, and click on Business.