Alt Investing: Putting Your IRA in Real Estate

The housing crisis has brought home prices way down, and the Wall Street crisis is making investors more than a little nervous. So now that mortgage rates are down, it could be an opportunity to take some of your retirement nest egg and invest it in real estate.

AP Home For Sale - Reduced Priced

We talked to two financial experts on what you need to know if you're considering such a move.

Paul Burkemper, president of Burkemper Group in St. Louis, Mo., says it's important to keep tax consequences in mind if you're interested in investing your IRA in real estate.

IRA Taxes Higher Than Capital Gains
If you are swinging for the fences with depressed real estate, keep in mind that gains in an IRA will ultimately be taxed as ordinary income versus the more preferential capital gains rate.

One of the benefits of real estate investing is the tax benefits (i.e. development and depreciation write-offs). These are moot inside of an IRA.

So Convert to a Roth First
Consider converting to Roth first and using Roth money to invest in real estate for tax FREE growth. If you are betting on real estate to rebound over the long run, then this approach makes sense. And, Required Minimum Distributions are not required out of a Roth.

IRA Less Liquid
Take into consideration the illiquidity of the investment and how it might impact ability to take RMDs. (May want to consider a REIT for greater liquidity/diversification)

Use Separate IRA for Real Estate
Use separate IRAs for each non-traditional investment. Whether it be real estate or another asset, you are better off separating them out. This way if the real estate investment violates the stringent IRS rules & regs regarding self-directed IRAs, only that investment amount becomes taxable versus all IRA assets if held in the same account.

Don't Violate IRA Rules
Watch how you use/handle real estate purchased in an IRA. Caution needs to be taken to avoid self-dealing which could render entire IRA taxable and subject to potential penalties.

Examples of prohibited transactions:
If you purchase a "fixer upper" and do the rehab work yourself (or even hire a relative to do it), that is considered self-dealing resulting in a full distribution of the entire IRA, which will be subject to tax and 10 percent penalty if you are younger than 59 1/2.

If you buy an investment property in Hawaii and rent it out but stay there one week of the year, that is self-dealing.

James Cox, managing partner of Harris Financial Group in Colonial Heights, Va., suggests looking at a more diversified approach.

Buy REITS Not Real Property
If you want to get into real estate with IRA dollars, look at more efficient means to diversify with real estate (think REITs) versus lack of diversification with the purchase of real property.

Don't Buy Your Own Home
IRA real estate purchases make the investment properties ineligible for depreciation benefits, capital loss deductions and for your own personal use (so no primary residence or vacation home!)

Don't Buy a Home For Your Child
With mortgages tough to come by, parents might find themselves tempted to serve as the bank for their kids and use their IRA dollars to buy a house outright. As an investment, their kids would make mortgage payments to them. BUT, this would very likely be considered a prohibited transaction by the IRS since family members would be using the house.

It's Best as an All-Cash Purchase
Keep in mind that use of leverage is a no-no, which means 100 percent capital for the real estate purchase - no mortgage! (taxes are payable on income/capital gains on leveraged portion-UDFI)

Don't Violate IRA Rules
It's easy to short circuit the IRA through "prohibited transactions" - so, if you decide to use IRA dollars, use Roth or split your IRA so you can use a separate IRA for your real estate investments.