Commercial Real Estate – In Your IRA?
As most of you know by now, IRA rules don’t restrict you to stocks, mutual fund shares, bonds, annuities and CDs. Because of the way the tax code is written, you can use your IRA money to take direct ownership of all kinds of different investments, including real estate.
Thanks to the availability of significant leverage, real estate is one of the most potent assets a skilled investor can place in an IRA. The combination of innate inflation hedging, potential for capital growth, and the expectation of a steady, growing and indefinite stream of rental income makes real estate an ideal investment to enhance a retirement income.
Why Commercial Real Estate?
Commercial real estate has many of the same advantages as residential real estate, listed above. But for some of our clients, commercial real estate has a few other advantages as well: It’s easier to “scale up” commercial space for larger accounts without having to buy many smaller properties. Commercial real estate can also generally be repurposed to suit a tenant more easily than a residential property in a market where residential property is underutilized. If you have a good tenant in mind, you can frequently make the deal happen.
Commercial real estate also involves much longer term leases than residential real estate. Residential properties will lease for a year at a time on a good day; but you can demand multiple years and even decade long leases on some commercial spaces – and tenants are delighted to secure them in exchange for security. These longer leases can go a long way to helping you ensure a steady stream of retirement income, without having to go crazy managing many different properties.
Further, you may find a much more inefficient market in smaller commercial properties. Many times, these little warehouses, storefronts and workshops are too big for the residential specialists to handle, but are still below the radar of institutional investors. When you go looking for property, you may find you’re the only one talking to the owner.
Special IRA Rules
Putting commercial real estate in an IRA for tax-deferred growth can be a tremendous way to leverage your real estate holdings while sheltering your rental income from taxes. And if you convert to a Roth IRA at some point, you turn that stream of rental payments into tax-free income for as long as you live.
But there are certain things to keep in mind when it comes to real estate assets in your IRA.
Watch your cash flows. You can roll money from other retirement accounts into your IRA to satisfy liquidity needs. But you can’t contribute more than $5,000 of new money (or $6,000 if you are over age 50) to an individual retirement arrangement in any one tax year –and then only if you meet some fairly stringent IRS limitations on your income. This means that if you need to make any major investments, repairs or renovations to the property, you will need to finance it from within the IRA, or have your IRA borrow the money from a non-prohibited source. Otherwise, the property must be self-sustaining.
Likewise, you can’t pull cash out of the IRA, except for certain specified hardship conditions, until you reach the age of 59 ½, lest you be held liable for any income taxes due on traditional IRAs, plus a 10 percent penalty.
Don’t Engage in Self-Dealing
You cannot use your IRA for any personal benefit, other than simply growing your IRA. Your IRA cannot do business with you. You can’t act as the paid property manager of the property, nor can you lend money to or borrow from your IRA. You can’t live on the premises, or even stay there overnight – even if you pay the market rent to the IRA. The same applies to your spouse, descendants or ascendants, their spouses, your financial and legal advisors working with you on your IRA and properties in it, and any entities they control.
Watch the Financing
IRS rules prohibit you from pledging your IRA as collateral for a personal or business loan. But your IRA can borrow money for its own use. All borrowed funds – and the goods and services they purchase – must remain in the IRA. You cannot commingle the proceeds with your personal money or any businesses outside of the IRA.
Furthermore, all loans the IRA takes out must be nonrecourse – the lender must have no legal claim on anything outside the IRA. Otherwise, you could “blow up” the whole account, and be forced to pay income taxes and penalties on the whole thing. If there’s any doubt, be sure to talk to a professional experienced in self-directed IRA investing before making any commitments. Not all advisors are familiar with the rules specific to self-directed IRAs
Commercial real estate can open up whole new worlds for the real estate investor, with access to pools of capital and partnership opportunities. And many properties can be had at very reasonable prices in today’s market. Expect to come up with some more significant down payments than residential property investors may be used to – on the order of 35 percent and up. That’s a blessing in disguise, in some ways, though, because unless the IRA has significant liquid reserves, it can be difficult to keep a property maintained, given the limitations on new money contributions to IRAs, unless the property is cash flow positive early on.
As always, be sure to work with an advisory team that is very familiar with the rules specific to real estate in self-directed IRAs, who know the rules, the court case precedents and the IRS revenue rulings governing the practice. Most conventional advisors are not experts in nontraditional investing in IRAs.
For more information, or to explore your options, call American IRA today at 866-7500-IRA(472). We look forward to working with you.