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“Just say NO” when considering putting Real Estate in an IRA

By Brett Danko, CFP^®

With the stock market volatility over the past year, many clients have been inquiring whether it makes sense to put money in real estate.

While one of my partners, Tara Conti, explores this general theme further in her newsletter article, I want to focus on one specific vehicle for real estate investment.

I have been asked numerous times over the past year if putting real estate in an IRA (known as a “self-directed IRA”) would be a prudent choice. The short and easy answer to placing real estate in your IRA is a resounding NO for the reasons outlined below.

Seven (7) Reasons NOT to put Real Estate in your IRA

1. You can NOT use leverage, i.e. no mortgage.

2. You can NOT use the property in any way - neither you, your spouse, kids nor grandkids can use the home. It must be rented out to others and used for investment purposes. Use it ONE day and it is deemed a full distribution subject to ordinary income tax and a 10% penalty if under 59½.

3. You lose the ability to do a tax free exchange called a 1031. A 1031 allows you to defer the gain from rental real estate forever as long as you invest in another rental property of equal cost.

4. You lose the 15% capital gain if you decide NOT to do a 1031 exchange and just take your profit. With an IRA, the money comes out as ordinary income.

5. You can NOT make any additions to the IRA beyond your $5K/year. What if the property needs major upgrades, etc??? Remember you can NOT do a mortgage.

6. If you mess up in any way with a "self-directed IRA", the entire IRA is deemed to be distributed. That means ordinary income tax and a 10% penalty if you make a mistake.

7. And last but not least, you have to take RMDs (Required Minimum Distributions) upon reaching 70½.

Please note there are always exceptions to the general rule, but I have not encountered a situation where it made sense. Why would anyone want to take the chance and risk a full distribution of the IRA assets?

We have researched the literature on "self-directed IRAs" using real estate and all the literature says it is the easiest thing in the world to do and it makes all the sense in the world. They also say your financial advisor will try to talk you out of it because they are trying to hold on to your assets. These marketers are partially correct – a knowledgeable financial advisor will try to talk you out of it, BUT for the right reasons (listed above), not selfish ones.

These self-directed real estate marketers are JUST trying to sell their products to help you set it up. They are shameless hucksters (in my humble opinion) and regular folks should stay far, far away from them.

Remember if you make the slightest mistake dealing with your self-directed real estate IRA, it will be deemed a full distribution subject to ordinary income tax and a 10% penalty if under 59½. OUCH!!! The firms that “helped” you create the self directed IRA and said it was such a great deal will offer little or no help or may even be out of business. OUCH again!!!

If you want real estate exposure, buy a REIT – it’s cheaper, more efficient, less hassle and provides better liquidity and diversification. (See Tara Conti’s article below, “Is Real Estate a Wise Investment?”).

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