If you use a self-directed IRA to invest in real estate, you better follow the rules or else you might lose the tax advantages of the plan. Failure to follow these rules could lead to severe penalties and taxes. Here are a few common mistakes that real estate investors make. Avoid these at all costs and you’re retirement savings will excel.
First off, never personally accept rental income. Assets in your IRA should not give you personal gains until you reach retirement and start taking distributions. If you own a rental property in your IRA, it must be maintained by the funds within the plan. Further, all profits from the property must be paid directly to the account. Therefore, your tenants should write rental checks directly to your self-directed IRA and not to you personally. Even if you were to move the funds from your personal account to the IRA, you would still be in violation and would face taxes and penalties.
Next, never deal with a disqualified person with your real estate property. This could lead to a prohibited transaction within your IRA. A disqualified person can include your parents, grandparents, children and spouses thereof. Having any dealings with any of these people with a property held in your IRA will lead to penalties. For example, you cannot buy a property from your father, rent out an apartment to your child or have your father-in-law manage a property. This is known as self-dealing and is strictly prohibited.
Similarly, you yourself cannot perform services on the property, such as maintenance, repairs or cleaning. It’s best to hire a property management company to oversee the day-to-day operations of the property. This way, you don’t risk performing a prohibited transaction yourself.
Lastly, always have enough cash in your IRA to cover all expenses involved with the properties held in your self-directed IRA. Not have enough cash when an emergency arises may lead to devaluing your IRA and thus ruining your retirement. Since all transactions must be paid out through the IRA, not having cash may cause you to sell other assets to pay for the problem, force you to take a nonrecourse loan or hurt the property’s value by not taking care of a problem until you have the cash.
Purchasing real estate in a self-directed IRA is a great way to build your nest egg, but only if it’s done properly. If you are interested in buying real estate with your retirement funds, contact a tax expert at the IRA Financial Group @ 800.472.0646. They can ensure that all rules are followed and your retirement funds are there when you need them!