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Pheobe Chongchua The IRA market is a multi-trillion-dollar industry of which experts say approximately two percent is invested in real estate and other nontraditional investments. Using your IRA to buy real estate is becoming increasingly more popular, but it opens the possibility of dangerous and costly mistakes if you don't know what you're doing.
"The way the law reads is if you benefit from your IRA prior to distribution of your IRA then you are in violation," says Patrick W. Rice, President of IRA Resource Associates, Inc. and author of IRA Wealth
He founded his company in the early 1990s and finds that even today people are surprised to learn they can buy real estate with their IRA. And those who do know it are often not completely familiar with the IRS landmines that exist. For instance, if you are buying a property using your IRA, but you don't have enough funds in your IRA, you'll need a loan. It's a non-recourse loan that is used because you personally cannot sign on a loan for your IRA.
"The IRA requires that any loan to the IRA be non-recourse; that's a Federal regulation. Non-recourse means that the lender on the property can only go after the property itself," explains Rice.
This, of course, differs drastically from the way a mortgage on your primary residence works. "So if you owned your own house and you borrowed money from the bank and the bank foreclosed on you; and the bank foreclosed for a price less than what you owed on it, the bank could then come after you personally. Well, on non-recourse loans the bank cannot," says Rice.
Another potential hazard of investing with your IRA has to do with who you buy the property with and when. Rice uses this example to show where the risk lies.
"You've got $30 thousand in your IRA, your mom's got $30 thousand, and you've got $40 thousand in your discretionary fund. You can go in and buy that for cash as tenants in common," says Rice. But timing is everything. Rice says, "The key about using tenants in common for IRAs is that all of the tenants in common must go in at the same time."
In other words, if you have your IRA buy a property and then you want others to buy into it later, you'll be in for trouble.
"So the IRA can't buy the property and then at a later date discretionary funds go in there—then you have a violation. But if you all jump in the pool at the same time, on acquisition, then you can do tenants in common," says Rice.
Rice says it's not just timing that you have to be concerned about when you're using your IRA to purchase real estate but also who you plan to have as partners.
"Other violations that are commonly made are when people are putting together LLCs or partnerships to acquire real estate and they bring in their family and friends to that LLC membership mix," says Rice.
He says with partnerships you have to watch out for disqualified parties. "We see a lot of errors made with people trying to do business with relatives. You can do business with brothers and sisters. You can do business with step-children or step-parents, but you can't do business with bloodlines going ascending or descending or the spouses of those descendents," says Rice.
One final thought before you invest with your IRA: Rice says make sure that you understand the difference between a custodian/trustee and an administrator.
"Custodians or trustees are governed by all the banking laws of the United States. They have their internal audits, they have external audits. They have FDIC insurance. They have liability insurance. They have a lot of oversight just like any bank the way it's regulated," says Rice.
"I could go out and be an administrator tomorrow just by putting that on my business card. There is no oversight. You don't have the FDIC insurance. You don't have somebody coming in every six months and checking your books," says Rice.
The key is to remember that with the right experts helping you navigate your way around landmines, purchasing real estate using your IRA can turn out to be a highly beneficial and rewarding experience.
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