Anybody do this? Sounds like you really need to know what you're doing.
Real estate attracts retirement funds
Buying property can be a good IRA investment, but many investors and advisers don't push the idea because of a web of complicated tax laws.
By Tom LaRocque
Special to The Denver Post
Article Last Updated: 03/08/2008 06:57:25 PM MST
Kim Norton bought a downtown loft using her IRA, sold the property and put the profit back
in her retirement account. Norton says real estate is a great alternative when investing an IRA.
(Helen H. Richardson, The Denver Post)
As a glitzy new high-rise was taking shape in downtown Denver, Kim Norton considered buying a condo there. The Glass House would be a hot property, she knew well, as a real estate agent employed by its lead developer, East West Partners.
In 2006, she took the plunge and purchased a one-bedroom, 760-square-foot loft at the preconstruction price of $215,000. The funds came not from her personal bank account but from a self-directed Individual Retirement Account.
Two years later, after renting the unit, Norton sold it for $330,000. The six-figure profit went back into her IRA, tax-deferred until she retires. She is now using the funds to purchase another property in Cherry Creek.
Real estate is little-known way to invest retirement funds. Many people, including even financial advisers, think it's illegal in an IRA.
"It is not illegal," said Bill Humphrey, principal of Entrust New Direction, based in Lafayette. The office is a member of The Entrust Group, a national firm that serves as an administrator in nontraditional IRA investing.
"A lot of people prefer real estate. That's where they've been successful and that's what they're comfortable with," Humphrey said.
To someone saving for retirement, real estate may be a good alternative to the turmoil of the financial markets.
In helping clients select IRA investments, most financial advisers say little or nothing about real estate, Humphrey said. Many have an interest in selling only securities, particularly if they represent big brokerage houses.
Even independent advisers tend to steer clear of real-estate investments in retirement accounts, largely because of the complexity.
"Compared to buying a hundred shares of IBM, it is complicated," he said.
Many Internal Revenue Service restrictions apply. For example, an offer to purchase property must come from the IRA, not from the person who owns the account. An account administrator signs the purchase contract, acting under the direction of the account owner.
After a property is purchased, the account holder can't personally pay expenses, such as utility bills. Checks are written from the IRA by the administrator. And income such as rent must flow into the IRA, not to an individual's personal bank account.
"The investment may not benefit the individual directly or indirectly" outside of the IRA, Humphrey said. All investing activity should be to grow the retirement account.
Investors sometimes dream up ways to skirt the rules, he said.
"They may think they can buy a condo in Maui and maybe rent it to their neighbor. Then the neighbor can invite them over as guests."
Such abuses, even if they were blessed by an administrator, wouldn't survive scrutiny by the IRS. Tax law prohibits the purchase of a property in an IRA for personal use by the account owner or for the benefit of family or friends.
The web of rules speaks loudly of the need for a willing and able administrator, said investor Norton.
"It is really important to work with someone who will keep you doing things the right way," she said.
One advantage is the ability to use leverage — borrowed money — to buy property. That's in contrast to securities. Brokers don't permit buying stocks "on margin" in an IRA because of the inherent price volatility.
Norton's $215,000 purchase was financed with $100,000 from her IRA and $115,000 borrowed from First Bank, based in Lakewood.
It is a "nonrecourse" loan. If it goes into default, the lender may recover only the assets within the IRA. The owner of the account, Norton, would not be liable.
"In our opinion, that's the only kind of loan that's proper within an IRA," said Pat Brady, president of First Bank's northern Colorado division.
That bank has done more than 100 loans to retirement accounts, including individual pension and profit-sharing plans, according to Brady.
Less leverage is allowed in an IRA loan. Compared to a conventional mortgage, in which someone might borrow 80 or 90 percent of the price of a home, an IRA loan goes up to 65 percent. Interest rates are higher, by about 0.5 percent or 1 percent, he said.
To invest in real estate, an IRA must be "self-directed," not the traditional type handled by most banks and brokers. Tax-deductible contributions to an IRA are limited annually according to age and income.
When building an account by contributing annually, it may take years to accumulate much capital, Humphrey said. Another route is to convert all or part of a 401(k) account from a former employer.
As a real estate agent herself, would Norton recommend using an IRA to buy real estate? Absolutely, she said. But she doesn't push the idea on clients.
"People have to get comfortable with the concept on their own," Norton said. "It may take a lot of research for someone to be willing to invest their retirement money this way."
