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Playing Poker with the IRS

John Shrewsbury, RICP®

Not to be preachy, but a verse in Proverbs reminds us “There is a path before each person that seems right, but it ends in death.” (Proverbs 14:12)

I think about that verse every time I hear someone say they want to buy rental property with their IRA money.  While the idea might not end in death, it could spell the death of your IRA as you know it if some very technical rules are not followed “to the T.”

Here’s what you need to know: Your IRA funds are tax-deferred.  If you buy real estate with IRA money in an improper way, the government can disqualify your IRA and charge you taxes and penalties. 

“Ouch” seems too trite of a word to describe the financial pain that could cause.  If your IRA is a significant part of your retirement it could also derail your entire plan.

“But John, it seems so easy.  I have all this money in my IRA and my buddy that does rental property is making a fortune.” 

Let’s count the ways this could go sideways:

  1. If you use IRA money as a down payment and mortgage the rest of the purchase, it’s disqualified.
  2. If you do work on the property yourself, it’s disqualified. You have to pay an independent contractor to do the repairs and you have to pay for it with IRA money.
  3. You can’t sell the property to your IRA (assuming you already own it,) you can’t live in it or use it for a vacation home. Otherwise, it’s disqualified.
  4. You can’t take credit for any operating loss on your taxes. Oh, and depreciation?  Nope, you can’t take that either.

Should I go on? 

There are other considerations like annual valuations of the property, required minimum distributions at 701/2, and finding a special custodian that will allow a “self-directed” IRA.

You Gotta Know When to Hold ‘Em, Know When to Fold ‘Em

Feels a little like playing poker with the IRS with your IRA money as the stakes and the IRS having the cards stacked totally in their favor.  For all of our clients who have worked hard to build up their savings toward replacing their paycheck at some future date, we say “fold” on this idea.  Oh, you will hear a lot of websites sell the idea, but it’s what they often don’t tell you that makes all the difference.

So, next time that real estate bug bites and your IRA looks like a giant bottle of Calamine lotion, stop. Talk to a financial advisor who can discuss alternatives to investing in real estate that don’t run the risk of running afoul of the issues we’ve outlined and therefore ruining what you worked so hard to build.

Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. Contributions to a traditional IRA may be tax deductible in the contribution year, with current income tax due at withdrawal. Withdrawal prior to age 59 may result in a 10% IRS penalty tax in addition to current income tax.

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