Many financial services companies won’t permit you to put money into real estate in an individual retirement account, or IRA, thanks to the growing amount of paperwork required and the additional Internal Revenue Service regulations that must be followed. However, the IRS does not strictly prohibit real estate investments in IRAs. Penalties can be severe if you don’t stick to all IRS regulations.
Self-Directed IRA
To be able to invest in real estate in your IRA, locate a financial services firm which will allow you to start a self indulgent IRA. A self respecting IRA is basically the same as a conventional IRA, but lets you purchase a wider selection of investments, such as real estate. Though you get to choose your own investments in a self-directed IRA, you cannot possibly be the custodian of your IRA, so you ought to find a custodian firm that’s familiar with managing real estate investments in IRAs.
Investment Property
Among the main regulations regarding real estate in an IRA is the property you purchase has to be a investment property just and not a home of any type. Consequently, vacation homes, second homes or homes where family members reside aren’t eligible.
Active Management
Among the tricks of putting real estate in an IRA is that you are not allowed to perform services which benefit the IRA. Under the strict interpretation of this principle, performing any active management of a property in an IRA is regarded as benefiting the IRA, so you need to refrain from doing so. This means that you are not allowed to perform maintenance work on the property or to collect rent from any tenants. To prove that you are not actively handling the property, you might choose to hire an external property management company to conduct your affairs.
Cash Flow
All money flow regarding your investment property has to flow into and out of this IRA to avoid running afoul of IRS regulations. In other words, you should pay for the property with money already from the IRA, and any rents or other proceeds from the property must be deposited directly back into the IRA. Combining this provision together with the IRS law that restricts loans against your IRA effectively means that you must cover property with money instead of with any type of mortgage.
Penalties
Penalties for not following IRS regulations are rigorous. If you are found to have breached any of the provisions regarding real estate in IRAs, the IRS can terminate your account and remove all tax-advantaged features out of it. Effectively, your IRA funds is likely to be regarded as distributed, resulting in regular income tax on the entire balance, and potential early distribution penalties of 10 percent if you are below the age of 59 1/2.