Tuesday, June 7, 2016

Using IRA to fund real estate can be tricky

FROM http://www.abqjournal.com/

Real estate is a permitted investment in either a traditional or a Roth IRA account. However, it is essential that the acquisition, operation or disposition of the property not result in a prohibited transaction as defined by IRC Section 4975. Engaging in a prohibited transaction with the IRA will result in loss of its status as an IRA with a (deemed) immediate distribution of the assets to the beneficiary.

The termination occurs as of the first day of the year of the prohibited transaction and the deemed distribution of assets will be subject to immediate tax and perhaps penalties for early distributions.


I have been asked this question many times. I usually begin by noting that there are many areas of tax law that I might be regarded as an expert in, but qualified retirement plans and IRAs are not within those areas.

In fact, there are not many people who are experts in these areas. That can be troublesome because many sponsors of self-directed IRAs will provide tax advice on real estate investments in IRAs that is less than definitive.

After my “no expert” introduction, I note two issues that are of concern. First, the penalty for violating the prohibited transaction provisions is much more severe than is typically encountered in tax planning – the immediate death of your IRA.

This penalty suggests the need for strict compliance with the rules. But my second issue is that the rules are not very clear, even to experts.

The prohibited transaction rules are found in two places – ERISA and the Internal Revenue Code. The Department of Labor administers ERISA and sometimes issues advisory letters on issues such as prohibited transactions.

The IRS protects the government’s interest in the tax laws and sometimes litigates cases dealing with prohibited transactions.

The need to consider both the views of DOL and IRS confounds getting clear advice on what constitutes a prohibited transaction. This is exacerbated by the death penalty issued to violators.

So advisers usually fail to give an actual “opinion” on prohibited transactions. Instead, they provide a “weasel worded” letter that concludes nothing. The letter is usually an insult to the average weasel.

We know prohibited transactions would include selling property to the IRA, buying property from the IRA, loaning money to the IRA, providing services to the IRA and receipt of any personal compensation.


So, in your case, I’m sure the argument is that the management services are provided to the LLC, not the IRA, and that you receive no personal compensation for any services.

But you should also avoid using your services to enhance the value of the IRA’s investment in the LLC. Providing value-enhancing services without compensation could be viewed as an indirect contribution to the IRA.

The Labor Department, in Opinion Letter 200-10A, allowed an IRA owner to be the general partner of a limited partnership that invested IRA funds in a Bernie Madoff fund. The IRA owner represented he would not manage the investments.

I’m trying to be more of a cautious adviser, providing an objective analysis and not a wet blanket. But, if the IRA investment is renovating homes and you are the manager, you need to avoid day-to-day oversight and handling any work yourself.

Even if services are not compensated, if they enhance the value of the IRA real estate investment, the value of foregone compensation by the owner can be an indirect contribution to the IRA.