It’s been a few years since your high school or college days. Alright, it’s been more than a few years, but the point is you can still remember how much you hated surprise tests— “pop quizzes” is what your teachers or profs called them. Well, no worries. If you do not do well on this one, your grades or GPA will not suffer, but you will gain some invaluable insights into Self-Directed Real Estate IRAs.
To begin with, investing in real estate through Self-Directed Real Estate IRAs will provide you with several benefits:
- Any revenue stream you receive from rental income is not taxed.
- The increase in the market value of your property is not taxed as it accumulates.
- If you decide to sell, any value growth from the sale avoids taxes while it’s inside the Self-Directed Real Estate IRA.
That’s the good news (and it is good news!).
A word of caution, however, as there are a few potholes to avoid along this mostly smooth road that could endanger the tax-advantaged status of your account. If your Self-Directed IRA engages in a prohibited transaction, the IRA is no longer considered to be an IRA, so there are rules to follow that tell you with whom you may deal and the type of transactions you may undertake with the assets in the IRA.
So, on with the quiz, and let’s find out what you already know and, more importantly, what you need to brush up on to keep your Self-Directed IRA safe. All answers are true or false:
- You and your spouse are the only “disqualified persons” in real estate transactions.
False: The list of disqualified persons is much longer and includes:
- The account owner.
- The account owner’s spouse.
- The accounts owner’s lineal ascendants and descendants and their spouses.
- Service providers and fiduciaries, which includes advisors, custodians, and administrators.
- Any entities—partnerships, corporations, estates, etc.– in which the account owner owns at least 50% of the voting stock.
- Any officer, director, partner, or anyone who owns 10% of an entity owned by the IRA.
- When one of these disqualified persons engages with the assets held in a Self-Directed IRA, it is deemed a prohibited transaction.
True: Disqualified persons and prohibited transactions go hand-in-hand, so do not proceed with any transactions that include a disqualified person!
- My Self-Directed Real Estate IRA owns a multi-family building, and I may lease one of the apartments to my son as long as he goes through the rental agency for the transaction.
False: Your son is a disqualified person and may not rent an apartment in any property owned by your Self-Directed Real Estate IRA, as it is considered to be a prohibited transaction.
- If I hire my granddaughter to weed the flower beds at a rental cottage owned by my IRA, this would be a prohibited transaction.
True: A disqualified person (your granddaughter) cannot provide goods, services, or facilities to an asset that’s owned by your Self-Directed IRA.
- My furnace just quit working, so I may borrow money from my Self-Directed IRA to replace it.
False: Borrowing from your IRA is a prohibited transaction.
- I will be assessed a 10% tax on any asset in which I engage in a prohibited transaction with a disqualified person.
False: The penalties are much more severe. If the IRS determines that you have engaged in a prohibited transaction with a disqualified person, then your account ceases to be a Self-Directed IRA as of the first day of that year, and all assets will be treated as having been distributed to you at their fair market value on January 1st. If the value exceeds the basis in your Self-Directed IRA account, the gain is included in your income and becomes taxable.
- I am allowed to transfer rental property that I own personally to my Self-Directed Real Estate IRA.
False: This is another prohibited transaction. Your IRA cannot receive property that you currently own.
- The prohibited transactions rules keep me from partnering with anyone else to purchase real estate in my Self-Directed IRA.
False: You may partner with others to purchase alternative assets, including real estate. Approved partners could be:
- Another investor: If you do not have the financial resources, it can be a way to pool the investment capital and share the risk.
- A relative: Although you may not buy from or sell to a disqualified family member, you are allowed to partner with family members to purchase a new investment.
- A group: Depending on the cost of the asset, you might need multiple partners.
How did you do? If you got all of them right, nice going! If not, you got to improve your understanding of disqualified persons and prohibited transactions.
Interested in learning more about Self-Directed Real Estate IRAs? Contact American IRA, LLC at 866-7500-IRA (472) for a free consultation. Download our free guides or visit us online at www.AmericanIRA.com.