Question: Can an IRA custodian invest directly in real estate within their accounts?
Answer: The answer is that IRA custodians are not required to permit customers to invest directly in real estate in their IRA accounts but some nevertheless offer this option. Custodians are free to choose which investment options they will allow and many simply do not want the administrative and legal hassle of real estate within the IRA.
The Internal Revenue Code permits real estate as a valid IRA investment. One of the important concerns for custodians with respect to allowing clients to purchase real estate directly with their IRA is the potential for a prohibited transaction. If the IRA owner engages in a prohibited transaction, the entire IRA is disqualified and deemed distributed as of the first of the year in which the prohibited transaction occurs. The effect is that the entire IRA account is included in income for the year and will be subject to the 10% early distribution penalty if the owner is under 59 ½. One example of a prohibited transaction is the restrictions on loans under these rules. One cannot loan money to his IRA or personally guarantee a loan taken by his IRA. Any loan obtained by an IRA must be a nonrecourse loan. The potential for violations of the prohibited transaction rules notwithstanding, there are other problems with holding real estate inside an IRA. As a result of loan restrictions, an IRA generally has to pay cash for the property because there is little ability for the IRA to borrow money to purchase the property. Moreover, there also must be sufficient cash inside the IRA to pay for improvements, repairs, and taxes and the ongoing costs of the real estate. Remember the IRA owner cannot add money to the IRA to pay these expenses. Another problem is that when the account owner turns 70 ½, minimum required distributions must be taken and real estate is not a liquid asset that is easy to distribute.
ABOUT STEVE SHANE
Steve Shane provides strategic counseling to clients in need of estate administration, charitable giving and business continuity planning while minimizing estate, gift, and generation-skipping transfer tax exposure. He offers legal guidance to clients on asset protection and the proper disposition of assets in accordance with the client’s objectives, while employing tax planning techniques such as the use of irrevocable trusts, life insurance planning, lifetime gifts and charitable trust. He is also experienced with drafting documents for business planning, the incorporation and application for exemption for Private Foundations and the administration of decedents’ estates.