Most of us understand the basics of homeowner’s insurance. But there are certain aspects of insurance that are especially important for Self-Directed Real Estate IRA investors to understand:
- The Self-Directed IRA, not you, has to be the payor and beneficiary of all insurance policies covering the property. This is because of the prohibited transaction rules that govern Self-Directed IRAs and other kinds of retirement accounts: You cannot mingle your own personal funds with those of the IRA. This means that all premiums have to be paid with funds from within the Self-Directed IRA. Furthermore, if you have a claim, you do not want the payout to go to you, personally, either. This would potentially trigger a taxable distribution, complete with penalties, and could endanger the tax-favored status of your account altogether.
- You should have American IRA, LLC, handle premium payments. Just as rent payments need to go to the Self-Directed IRA itself, and not you, personally, you should have your Self-Directed Real Estate IRA administrator (such as American IRA, LLC!) or custodian send in your premium payments. If you send premiums in from your personal checking account, and the IRS finds out, you could again endanger your account’s tax-advantaged status. If it is revoked, you could have a major tax hit and a lot of penalties if you are not yet age 59½.
- If you have tenants, you need landlord insurance. If you are renting out the property, or plan to, you should have a landlord insurance policy. A regular HO-3 homeowner’s insurance policy will not cover you adequately. Landlords take on a lot of risks that homeowner’s insurance is not designed to cover. For example, if your tenant causes damage to a neighbor’s property or injures a neighbor, landlord insurance’s liability coverage is designed to cover it. If your tenant accidentally sets fire to the house and the fire spreads to a neighboring property, or if a tenant trips on a loose stairstep, landlord insurance is designed to cover it. Homeowner’s insurance will not. If you try to get by with just a homeowner’s insurance policy, and the insurance company finds out it’s a rental property, they will probably deny the claim altogether.
- Flood, sinkhole and earthquake insurance require separate policies. Most properties should have flood insurance, and mortgage companies typically require it as a condition of the loan. If you live in areas prone to earthquakes and sinkholes – or as the insurance industry calls them – catastrophic earth movement events – these also require separate insurance policies or riders. They are not covered under off-the-shelf insurance policies. And again, it should be your Self-Directed IRA listed as a beneficiary, not you.
- Vacant properties need special coverage. If your Self-Directed Real Estate IRA property is vacant for 60 days or more, or you believe it will be, contact your insurance agent and arrange for vacant property coverage. Vacant properties represent a higher risk to insurers than companies with a tenant in them, since flooding, mold and other events can go undetected for weeks. They also tend to attract vandals and vagrants, and vagrants are frequent drug users and may also engage in criminal activity that may damage the home (e.g., meth production) and generate liability for the Self-Directed IRA as the property owner.