Investing in real estate with a self-directed IRA could be a great way to diversify your portfolio while building wealth on a tax-deferred or tax-free basis. To maximize your opportunity with this type of investment there are some things you need to know and rules you should follow.
Here are six rules to keep in mind:
1. Your IRA cannot purchase property owned by you or another disqualified person. A real estate IRA may seem like a great way to buy real estate you own and personally use. However, this is considered a prohibited transaction and results in taxes, penalties and the loss of the IRA status. A disqualified person includes you, your spouse, grandparents and great grandparents as well as any children or grandchildren. Basically, any lineal descendant is disqualified. This means any generation before you or after you is disqualified, but it does not include siblings.
2. Your self-directed IRA cannot provide you with any benefits. The purpose of an IRA is to fund your retirement. This means that you or any other disqualified person may not benefit from your IRA until you’ve reached retirement and begin taking distributions from your account.
3. IRA investments are uniquely titled. Remember this: You and your IRA are two very separate entities. This means that all investment and legal documents regarding the IRA must be titled in the name of the IRA and not in your personal name.
4. IRA investments that use financing might be taxed. Your IRA may use financing to purchase real estate by using a non-recourse loan. This means that the loan is secured only by the property and not secured by your personal assets or any other IRA-owned assets. If your IRA does use financing for the real estate purchase, unrelated business taxable income (UBTI) could apply.
5. Real estate expenses are paid from your IRA. Going back to #3 again, you and your IRA are separate entities. So, no personal funds should ever be commingled with your IRA funds during a real estate investment. All expenses related to the real estate investment (including earnest money) must be paid with funds from the IRA.
6. Real estate income must be returned directly to your IRA. Seeing a trend here? Since your IRA and you are separate entities, any income from the real estate investment belongs to your IRA and must be returned to your IRA. You should not take constructive receipt of any income generated from an IRA-owned property.
Investing in real estate with your STRATA offers many benefits. Keep these six things in mind, and follow the rules for real estate IRA investments. If you don’t, the consequences can be a hefty fine or other serious tax implications.
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