Q&A: Buying Real Estate

A relative who’s a real estate lawyer in another state suggested that I open a self-directed IRA and then purchase a rental income property inside it.

QA Real Estate

Question: A relative who’s a real estate lawyer in another state suggested that I open a self-directed IRA and then purchase a rental income property inside it. But I’ve been unable to find a financial analyst or a tax person to help. Nobody in my area seems to have much knowledge about this strategy. What are your thoughts?

Ric: We don’t recommend investing in real estate through a self-directed IRA for lots of reasons.

First, you cannot get a loan when purchasing property inside an IRA. You must pay cash, says the IRS.

Once you make the purchase, you have to use the IRA’s assets strictly. You must pay for all maintenance, repairs and property taxes from the IRA.

You are not allowed to pay any bills with money from outside the IRA. And because it’s an IRA, you must begin to make annual withdrawals starting at age 70½. But wait — a house isn’t a liquid asset. You can’t sell the living room to raise cash. So how will you generate the cash you need to make the required distribution? This burden would not exist if you bought the property outside the IRA.

If and when you finally do find a custodian willing to manage the account — they do exist — you’ll typically be charged 1.5 percent per year. That’s a fee you could avoid by not purchasing inside the IRA.

When you finally do generate profits — if the house grows in value and you earn rental income — those profits will be taxed as ordinary income because they’re inside an IRA. You lose the tax benefits of real estate ownership that are otherwise available to taxpayers, including depreciation and amortization, as well as capital gains treatment on your profits.

So tell me, why do you want to buy the property inside an IRA? It makes no sense — and that’s the reason you’ve found it difficult to find anyone to help you. I’m not saying you shouldn’t buy real estate. I’m saying not to buy real estate inside an IRA. Sorry if this isn’t the answer you wanted to hear.