In 1974 Congress passed the ERISA, Employee Retirement Income Security Act making retirement plans possible. When this act was passed investors gained access to retirement options with only 2 exclusion, Life Insurance and collectibles. It allowed for people to use Real Estate as a tool for their IRA contributions.
Self directed IRAs allow for investors to obtain more control. When choosing a self directed IRA for Real Estate you should chose a firm that specializes in the tax implications and rules. The tax rules are complicated and should be understood to avoid IRS implications.
Occupied Real Estate
The main rule to remember is you can’t occupy the property for personal use. It is an investment property, not personal property. You can rent the property to brothers or sisters, but you can’t rent to your parents, your children or your spouse. The rent can be used for the purpose of benefiting IRA only, not the individual. The rules the IRS has put in place are designed to prevent the risk of self-dealing. If the rules are violated and self-dealing is discovered, the IRA loses the benefit of tax-deferred or tax-free status.
It is important to identify who disqualified persons are. Disqualified persons are describes as:
- IRA owner
- IRA owner’s parents and grandparents
- IRA owner’s children or grandchildren
- IRA owner’s step children or daughter/son in-laws
- Investment Advisers, Fiduciaries and Business entities where any disqualified persons have more the 50% interest or greater.
The Real Estate purchased for a Self Directed IRA can be commercial, residential, renovated property, farmland, raw land and new construction. It is important to identify and avoid the prohibited transactions established by the IRS:
- Your IRA can’t buy or lease real estate you own from you. You are a disqualified person and selling, leasing or exchanging of the property between you is prohibited.
- Any disqualified person can’t extend credit or become personally liable for a loan used to purchase real estate for the IRA.
- A disqualified person can’t furnish goods, service or facilities used in for the purpose of the real estate for the IRA, for example, you can’t use your own items to furnish the IRA rental.
- You can’t purchase property for the future or occasional use of a disqualified member, for example a time share your grandparents plan on using during the summer is prohibited.
- You personally can’t receive an income from the IRA real estate
If the IRS determines you have violated the rules of the IRA you will face sever tax penalties. The penalties are applicable to all the IRA assets incurred on the first day of the year the violation was found to have occurred. The purpose of these investments is to benefit the IRA, not the person. If you follow the IRS guidelines and remember to keep yourself out of the equation, you will less likely run into trouble with the IRS.