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4 Mistakes to Avoid in Your Real Estate IRA

Investing in real estate through a self-directed IRA offers many tax advantages to real estate investors. With these advantages, comes a set of rules and regulations that must be followed in order for the IRA to remain compliant and maintain its tax-advantaged status.

If these rules are broken, the account owner could face significant taxes and penalties.

This article covers four common mistakes investors make when investing in real estate with a self-directed IRA. To remain in good standing, avoid all of these scenarios, which break the rules regulating IRAs.

1.  Personally Accepting Rental Income

nest egg

Protect your nest egg and
avoid taxes and penalties.

One of the caveats of owning real estate through a tax-advantaged retirement account is that your assets are not supposed to bring you personal gain until you start distributing them upon retirement.

To put it another way, you and your IRA are looked at as two separate entities, and the lines between you and your account cannot be blurred.

This distinction means that a property purchased through your self-directed IRA must also be maintained through your self-directed IRA. All costs associated with the property must be paid directly from your account funds, and all profits must be paid directly into your account.

These rules apply to rental income, which should flow directly from the tenant into your IRA. It would be a mistake, for example, to accept a rent check made out to you personally, then write a personal check to your IRA for the same amount. Your tenants must make their checks out directly to your self-directed IRA .(Your administrator or custodian can provide a format for addressing checks to your IRA.)

If rental income passes through your hands before being deposited into your retirement account, you could face excess taxes and penalties.

2.  Transactions with Disqualified Persons

Certain people are considered disqualified when it comes to your self-directed IRA transactions, and dealing with them could lead to prohibited transactions.

For example, you and your lineal ascendants/descendants, and spouses thereof, are considered disqualified, so buying property from one of them would be prohibited. Similarly, renting out one of your IRA-owned properties to a disqualified person, or hiring one of them to perform a repair, would also be prohibited.

Participating in a single prohibited transaction could eliminate all of the tax advantages associated with your IRA, as well as incur additional penalties. So be careful! More information: The Real Estate IRA – Prohibited Transactions and Disqualified Persons

3.  Performing Property Services Yourself

As mentioned above, you are considered a disqualified person in relation to your self-directed IRA. Because of this, you cannot provide personal services to the property without risking a prohibited transaction.

You cannot perform repairs, cleaning, or other maintenance work that would typically require hiring outside help. For this reason, most real estate IRA investors hire a property management company, rather than managing the property on their own.

Similarly, it’s good to have a list of trusted service providers to handle any problems that arise with the property.

4.  Anything That Eliminates Your Cash-Cushion

Because all of the costs associated with your IRA property must be paid directly from your IRA, most investors find it necessary to keep a cash-cushion reserved in their accounts to cover unexpected expenses.

Imagine that one of your IRA properties suffers $3,000 in damage, and your IRA only has $1,700 in cash available. Would you sell an asset to cover the remaining costs? Would you leave the damage to worsen until the cash was available? Would you take a non-recourse loan?

Avoid this dilemma by ensuring that your account has a comfortable cash-cushion to rely on.

Eliminating tax burdens can be a great help to real estate investors looking to build a nest egg, but any of the above transactions could eliminate all the benefits you have accrued and send you 10 steps backward.

Make sure you avoid transactions like these to keep your account working for you, instead of against you!

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About the Author...

Hubert Bromma is founder and CEO of The Entrust Group, He is a well-known authority on the diversification of assets in tax-free and tax-deferred plans, with a specific focus on real estate investing.

Mr. Bromma has written several books, including "How to Invest in Real Estate and Pay Little or No Taxes," and “How to Make Money in Alternative Investments.” He has also been a frequent guest on CNBC, Bloomberg, MarketWatch, and other financial media programs.

If you have any questions, please contact The Entrust Group for more information.

Comments

  1. Cindi says:

    You said: “If rental income passes through your hands before being deposited into your retirement account, you could face excess taxes and penalties…Your tenants must make their checks out directly to your self-directed IRA.”

    I am looking at doing a self-directed IRA with LLC, the so-called “checkbook IRA”. Two of us are going to pool funds from our individual IRA’s to purchase this property. In this case, can the rent be written to one of the IRA’s and then a portion of it transferred to the other IRA?

    Thanks

    • Good question, Cindi! Unfortunately, this is not typically acceptable. In the case of a partnership, two separate checks reflecting the partnership division would have to be written.

      For example, let’s say Bob and Jenny pool IRA funds to purchase a property at a 60/40 split, respectively. The tenant would have to write one check to Bob’s IRA for 60% of the rent, and another check to Jenny’s IRA for 40% of the rent.

      However, some administrators will make exceptions when both IRAs are held within that one establishment, as the funds can be easily separated between the two accounts before deposit. You would want to check with your administrator to make sure. Entrust has allowances for this, but the specific details of each investment situation are important to determine whether this would be allowable or not. With an IRA LLC, for example, things can be more complicated, as it may not be the IRA that owns part of the property, but rather the LLC which holds ownership. In that case, the funds would have to be split between an IRA and an IRA-owned LLC, which is more questionable.

      It is hard to say for sure either way without knowing more details of your situation, but I hope that helps! Please let me know if you have any more questions.

      Gary Kowalski
      Director of Sales
      The Entrust Group

  2. Tim Sweeney says:

    Thanks for the very good article.
    Do you have any suggestions on non-bank financing sources in the Reno area for the purchase of a 27-unit apartment building? We have the money in our IRA Project LLC to make a 25% down payment and to still have a cushion for unforeseen expenses, but the seller won’t do a carry back loan and we have a personal bankruptcy that is too recent for the banks with their inflexible rules. The purchase price is $1,050,000, so we need about $790,000 from one or more investors or lenders.

  3. Douglas Moysey says:

    Thank you for great advise.
    1 question.
    We found a property that has 2 separate single family homes on it. Can we split the transaction and pay 65% of price which represents the bigger of the 2 houses out of the IRA funds and 35% for smaller of the 2 houses out of our taxable cash account. We then would live in the smaller house. We would put the larger house in the IRA and the leave smaller out of the IRA. We then would rent the larger house and put rent from it into the IRA and pay related expenses out of the IRA with regard to the larger house.
    Can we split the property, part in the IRA and other part out of an IRA.
    TY
    Doug

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