Most of the time, real estate investing works out extremely well for long-term Real Estate IRA investors. But there are still some traps and pitfalls – particularly for investors who choose to manage their properties themselves, rather than working through a property manager. Here are five of the most common mistakes we’ve seen rookie landlords make:
1.) Bad tenant screening. Most Real Estate IRA nightmares come from a failure of tenant selection. One bad tenant – someone who adopts 26 cats into your ‘no pets’ condo, for example, or an angry deadbeat tenant who squats for two months and then vandalizes the place on the way out the door after you evict him – can destroy the profitability of your investment for a long time. Have a realistic, written rental criteria and stick to it. Make sure to do a background check on every adult who lives in the property, as well as a criminal background check, without exception. Don’t fall for ‘sob stories,’ and trust your instincts.
2.) Renting without a lease. All Real Estate IRA owners should have a fully-completed rental application and a full and complete lease drawn up in accordance with the laws in your state – without exception. Too many rookie landlords rent on a handshake agreement, which are never sufficiently detailed, even assuming the utmost good faith on the part of both parties, and nearly impossible to enforce in court. Don’t settle for a generic lease package you buy wrapped in cellophane at the Home Depot. Have an experienced attorney draw up the lease for you.
3.) Renting or lending use of the property to family. Yes, it’s tempting to allow your son in law to stay in the property you own in your IRA when he’s in town for a week and your property is empty anyway. But if you do so, and the IRS gets wind of it, they could disallow your entire IRA, forcing you to pay a small fortune in taxes and penalties. Self-directed IRA rules strictly prohibit renting or leasing to or otherwise using IRA assets to benefit yourself, your spouse, descendants and ascendants and their spouses, any entities they control and any advisors who give you advice about your Real Estate IRA in a fiduciary capacity.
It also means you can’t hire your son to be the property manager of the company, and you can’t hire a landscaping property controlled by your mother-in-law to do the landscaping.
4.) Poor understanding of housing discrimination laws. It is very easy for inexperienced landlords to run afoul of federal and state housing discrimination laws – even if they are well-intentioned. Landlords and property managers have landed in hot water with housing regulators over suggesting in an advertisement that their homes would be great for younger couples, or not great for children, for example. Even innocently asking an applicant if she has children, or asking an applicant with a foreign accent where he is from, are possible grounds for a housing discrimination lawsuit. There are thousands of potential traps that can ensnare unwitting landlords if they are not careful about how they advertise and market their properties and interact with the public, including renters and applicants.
5.) Failure to adequately insure the Real Estate IRA property. It’s your retirement security. Protect it. You don’t get to take a property and casualty loss on property in an IRA, because there’s no current income from assets within an IRA to deduct against. That said, too many landlords mistakenly assume a standard homeowner’s insurance policy will protect their Real Estate IRA rental property. It won’t. Standard homeowner’s policies are not designed to cover rental property, with their added array of potential risks and liabilities. If your insurance company learns you’re renting the property out, and you file a claim on a homeowner’s policy, your insurer will probably refuse to pay the claim – leaving you holding the bag.
It’s critical to purchase a landlords insurance policy on Real Estate IRA property, not just a landlord’s policy. These policies will help protect you against the unique risks and liabilities that homeowners insurance policies just won’t cover, including dog bite claims caused by your tenant’s Rottweiler, for example, or a renter slipping and falling in your property’s bathtub.