The ERISA consultants at the Columbia Management Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs and qualified retirement plans. A recent call with a financial advisor in Michigan is representative of a common inquiry involving real estate in IRAs. The advisor asked:
“My client is planning a sizeable rollover of plan assets to an IRA and would like to invest the IRA in real estate. Can she do that?”
Highlights of Recommendations
• Yes, if your client and the IRA meet certain conditions, it is possible to invest all or a portion of an IRA in real estate. Caution: Failure to meet the conditions could cause your client to be involved in a costly prohibited transaction pursuant to Code Section 4975.
• Generally, a prohibited transaction includes any direct or indirect acquisition of property for the IRA from a “disqualified person” or sale of IRA property to a disqualified person. Disqualified persons are those who, by virtue of their relationship to the IRA or property, may be in a position to self-deal — including, for example, the IRA owner, IRA beneficiaries and certain of their family members (see Code Section 4975(e)(2)).
• An IRA involved in a prohibited transaction loses its tax-exempt status; the assets are included in the IRA owner’s taxable income; and the owner could be subject to a 10% penalty if under age 59-1/2.
• While IRA law does not prohibit investing in real estate, IRA trustees are not required to offer real estate as an investment option; they are permitted to impose additional restrictions on permissible investments. Because of administrative burdens, many IRA trustees do not permit IRA owners to invest IRA assets in real estate.
• Here are the key considerations when investing IRA assets in real estate:
— Review the IRA plan agreement language for any restrictions on investing in real estate. Generally, your client will want to establish what is known as a self-directed IRA, which means she will decide how the IRA assets will be invested.
— The IRA (not the IRA owner) must own and manage the real estate for the IRA. All transactions involving the real estate must be completed through the IRA trustee — not the IRA owner.
— The IRA owner and certain family members may not personally utilize or benefit from the real estate investment in the IRA (e.g., they may not live on the property).
— The IRA cannot purchase the real property from the IRA owner or other disqualified persons.
— Despite the real estate investment residing in a tax-deferred IRA, if the property generates income for the year, for example, through rent paid to the IRA, the IRA may owe taxes on the rental income, which is unrelated business income (UBI). If UBI tax is owed, the IRA trustee is required to file an IRS Form 990-T, "Exempt Organization Business Income Tax Return," and pay the tax owed from the IRA.
— The real estate will need to be valued at least annually in order to report the fair market value for the IRA.
Conclusion
IRA owners interested in investing in real estate through their IRAs should seek legal and tax guidance as there are many considerations and requirements to fulfill in order to avoid engaging in a costly prohibited transaction.
The Columbia Management Retirement Learning Center Resource Desk is staffed by the Retirement Learning Center, LLC, a third-party industry consultant that is not affiliated with Columbia Management. For informational purposes only. Please consult a tax advisor or attorney for specific tax or legal needs. © 2013 Columbia Management Investment Advisers, LLC. Used with permission.
