Apparently, reality TV shows are now providing tax advice!. The number one questions across the country this year are from clients attending “real estate” seminars and being told to use their IRA to buy and flip homes. Technically legal, the use of an IRA to buy real property is a classic example of promoters misleading taxpayers into horrible tax problems. Here are 13, yes 13, reasons why putting an IRA in real estate is such a bad idea.
1. Where do you get a trustee? I am sure the promoter of the plan has an idea!
2. “Flipping” houses in an IRA creates trade or business income inside the IRA. Trade or business income inside an IRA is subject to a 35% UBIT rate on profits >$1,000.
3. Performing maintenance on the property inside the IRA is a disqualified self-dealing transaction under IRC Sec. 4975(e)(2)(C) which then treats the IRA as if it has distributed the entire FMV of the property as a taxable distribution.
4. What do you deduct with an annual rental loss? (Answer-you don't!)
5. You cannot use it to buy an office building that you are going to use yourself, even if you pay fair rental value or it is treated as a complete withdrawal at FMV and subject to penalty if you are under 59 and 1/2.
6. You cannot use it to buy a vacation property if you plan on using it yourself, including at FMV. You can’t rent from it or to it, nor can your family!
7. What happens if cash flow is not adequate-how do you get more money in the IRA without paying the 6% excess contribution penalty or rolling good money into bad?
8. How do you take a required minimum distribution from an IRA in real estate?
9. If the real estate is leveraged with debt in the IRA and income from the leveraged amount (rental or sale) is taxed to the IRA as unrelated business income at 39.6%. Form 990-T is required and if tax is owed it is treated as a taxable distribution when paid!
10. If the IRA owes unrelated business income and the tax is paid out of the IRA it is treated as an early withdrawal subject to tax and potential penalty.
11. Owning real estate outside the IRA will generate capital gains on sale, while inside the IRA it creates ordinary income. (Just like with stock)
12. Real estate sold at a loss outside the IRA is deductible, but real estate sold at a loss inside the IRA is not deductible.
13. Because land is considered an illiquid or non-traditional investment it must be valued by the trustee every year.
1. Where do you get a trustee? I am sure the promoter of the plan has an idea!
2. “Flipping” houses in an IRA creates trade or business income inside the IRA. Trade or business income inside an IRA is subject to a 35% UBIT rate on profits >$1,000.
3. Performing maintenance on the property inside the IRA is a disqualified self-dealing transaction under IRC Sec. 4975(e)(2)(C) which then treats the IRA as if it has distributed the entire FMV of the property as a taxable distribution.
4. What do you deduct with an annual rental loss? (Answer-you don't!)
5. You cannot use it to buy an office building that you are going to use yourself, even if you pay fair rental value or it is treated as a complete withdrawal at FMV and subject to penalty if you are under 59 and 1/2.
6. You cannot use it to buy a vacation property if you plan on using it yourself, including at FMV. You can’t rent from it or to it, nor can your family!
7. What happens if cash flow is not adequate-how do you get more money in the IRA without paying the 6% excess contribution penalty or rolling good money into bad?
8. How do you take a required minimum distribution from an IRA in real estate?
9. If the real estate is leveraged with debt in the IRA and income from the leveraged amount (rental or sale) is taxed to the IRA as unrelated business income at 39.6%. Form 990-T is required and if tax is owed it is treated as a taxable distribution when paid!
10. If the IRA owes unrelated business income and the tax is paid out of the IRA it is treated as an early withdrawal subject to tax and potential penalty.
11. Owning real estate outside the IRA will generate capital gains on sale, while inside the IRA it creates ordinary income. (Just like with stock)
12. Real estate sold at a loss outside the IRA is deductible, but real estate sold at a loss inside the IRA is not deductible.
13. Because land is considered an illiquid or non-traditional investment it must be valued by the trustee every year.