Time to Winterize Your Real Estate IRA Properties

It’s that time of year again! The arctic winds are blowing, and freezing weather is already affecting our country’s northern regions. That means it’s time to take final steps to winterize your real estate IRA properties.

The first step: Educate your tenants.

Your tenants are your most important line of defense in preventing or mitigating damage to your real estate IRA property. They are in a position to directly observe trouble brewing, and to take steps to ensure the damage is minimal. But not every tenant knows how to winterize a home.

Most of them want to save money on utility costs, though, and so will generally be happy to read through a newsletter or pamphlet coaching them on how to winterize their homes. The Landlord Protection Agency has published this handy list of reminders that you can use to remind your tenants of their responsibilities. 

Here are a number of measures all self-directed IRA owners in cooler climates should be taking to protect your valuable real estate IRA investment.

1.) Have the furnace and chimney professionally serviced.

2.) Seal windows and doors. Install winter draping, if necessary.

3.) Flush the water heater. Flushing the system every two years at least can help remove mineral buildups that can harm the unit and the pipes.

4.) Inspect your roof. Ensure that there are no missing/damaged tiles or shingles. Remove leaves and other debris from the roof and gutters. This helps prevent excess ice and snow from accumulating and causing damage.

5.) Drain and store garden hoses.

6.) Blow out lawn sprinkler systems. Otherwise the water in your sprinkler pipes could freeze and cause a burst pipe.

7.) Change HVAC filters

8.) Remove window air conditioning units.

9.) Install insulated windows and doors.

10.) Prune trees and shrubs near the house. Snow and ice accumulating on trees can cause branches to collapse, damaging structures, autos and possibly people.

11.) Caulk or cover cracks in exterior walls. Cold air can enter through cracks in drywall, brick or any other material and eventually cause vulnerable pipes to freeze and burst.

12.) Wrap or insulate all pipes you can get at. Again, this step could be crucial in preventing pipes from freezing and bursting. This is important: A burst pipe can cause a lot of water damage in a hurry. Nationwide, the average cost to repair home water damage runs from $1,062 to $4086, according to research from Home Advisor.

Remember, one burst pipe or snow-damaged roof can destroy the profitability of a real estate IRA property for an entire year. Left unchecked, water damage from a burst pipe can cause drywall rot, lead to mold and even render a real estate IRA property uninhabitable.

The Tax Cuts and Jobs Act’s Effects on Real Estate, IRAs

The Tax Cuts and Jobs Act, the sweeping tax reform law signed into law last week by President Trump, includes some important provisions for our real estate investor clients, who hold investment properties inside and outside of their real estate IRAs.

Most notably for real estate investors, the new law rolls back the amount of mortgage interest that individuals can deduct for higher-priced personal residences. Prior to the passage of the TCJA, individuals could deduct the interest they paid on qualifying mortgages on balances up to $1.1 million. Under the new law, the mortgage interest deduction on personal residences is capped at $750,000. That’s still much higher than most homes are worth, but some larger homes and homes in more expensive markets will certainly be affected.

The change does not affect mortgages held within real estate IRAs or investment properties. Interest on investment properties is still fully deductible. But it could put a damper on the market for higher-priced homes in general.

An analysis by Zillow found that currently, 44 percent of American homes had mortgage interest payments that were high enough to make it worthwhile for taxpayers to itemize in order to deduct home mortgage interest. After the law takes effect, about 14 percent of them will be in that boat.

Real estate IRA owners, however, will be compensated by much lower taxes on income from traditional IRAs, including real estate IRAs. The same goes for self-directed 401(k)s, SEPs, SIMPLE IRAs and other tax-deferred retirement accounts.

First, your standard deduction is nearly doubling – up to $12,000 for individuals and twice that for married couples. So your first $12,000 or $24,000 of income is tax free.

Furthermore, the tax rates on taxable income are lower. So you pay a lower percentage of tax on income over and above your standard deductions.

The real estate industry hasn’t been entirely happy with the tax cut bill: Moody’s recently forecasted that the law’s provisions would result in 4 percent lower home values by the summer of 2019 than they would have had the bill not passed.  

The culprits? The combination of the cap on mortgage interest deduction, as well as a cap on state and local interest tax deductions that will affect people in high tax states.

That doesn’t mean Moody’s thinks prices will fall by 4 percent. Just that they are likely to rise more slowly than they would have without the bill.

According to Moody’s analysis, most of the negative effects on home values will be felt in pricier markets like San Francisco, Los Angeles and New York.

The Case for Real Estate In Your Real Estate IRA

It was a nasty crash, but it was eight years ago. Since then, real estate asset prices have been relentlessly marching upward. While nothing is ever certain when it comes to investment, there are indications that the real estate bull market still has room to run – and that’s good news for Real Estate IRA investors.

Yes, the Federal Reserve has been gradually increasing interest rates. But that hasn’t helped bond yields as much as it probably should: Interest rates on CDs, money markets and shorter-term bonds are still much lower than historic averages, while interest rates on mortgages remain quite low compared to rent yields in most markets, combined with the potential price appreciation upside of real estate investing. Again, Real Estate IRA owners know that while there is obviously no certainty that real estate prices will continue to rise, assets are likely to continue to flow into real estate from weak-yielding bond markets as long as yields from traditional income-producing assets common to retirement accounts remains low.

Meanwhile, though the stock market seems very high at current levels, corporate bonds have been very highly correlated to stocks in recent years, giving investors very little reason to accept the meager yields available in them. This, again, tends to drive assets to alternative asset classes, including real estate – boosting prices in the aggregate.

The wealthiest investors and institutions are quite aware of this, and they are increasing their allocation to real estate in their own portfolios. A recent survey by Tiger 21 found that wealthy investors have an all-time record high (since they began tracking it in 2007) of 33 percent of their portfolios committed to real estate, including a Real Estate IRA.

The allocation to real estate and a Real Estate IRA comes at the expense of hedge fund exposure and equities. So the much-followed “smart money” appears already to be cutting back on their exposure to the stock market in favor of alternative assets.

Hedge fund allocation is at a record low of 4 percent, with hedge fund managers in the proverbial dog house as the traditional “two-and-twenty” compensation proves unwieldy in a low interest rate environment: Two percent fees takes up half the yield when interest rates are at 4 percent! And that pushes hedge funds further and further out on the risk curve.

Meanwhile, real estate continues to outperform, with REITs (real estate investment trusts) returning an average of 7.91 percent per year over the long term. Leveraged, those who own real estate directly using a self-directed IRA can potentially do much better – though leverage increases risks as well.

Here in the Southeast, real the real estate market is humming along, with South Carolina real estate experiencing a full-on boom. Vacancy rates have plummeted while new construction is racing to meet demand. Commercial vacancy rates in Lowcountry areas is below 10 percent, thanks to a local unemployment rate of just 3.8 percent in the area. Upstate South Carolina is experiencing a job boom, as well, with BMW leading the way, and attracting more job creation in its wake.

“The commercial real estate market in South Carolina is in exceptionally good shape,” said Mark Vitner, senior economist for Wells Fargo of Charlotte.

But experts are saying that prices here in the southeast have not caught up with the economic reality. Property can still be had at a very reasonable price for Real Estate IRA investors.

“We haven’t seen property values skyrocket because we haven’t seen as much foreign capital come into the state to overheat the market,” he said.

Real Estate IRA – Special Considerations for Vacant Properties

We are seeing more interest among Real Estate IRA enthusiasts in purchasing distressed and vacant properties.

Many times, the Real Estate IRA investor can purchase a promising vacant property at a substantial discount to its intrinsic value, which make these properties attractive value investments – especially for those Real Estate IRA investors who have the capital to upgrade these properties and make them once again attractive to tenants at a reasonable rent.

But as long as a property is vacant, there are some special considerations that investors need to consider:

  • Vacant properties are susceptible to vandalism
  • They are attractive nuisances to children.
  • They may attract vagrants
  • Vacant properties are sometimes occupied by squatters
  • If a child, vagrant or squatter is injured on the property, you (or your Real Estate IRA) could be held legally liable for the injury.
  • Leaks, mold and other problems can go unobserved for weeks or months – making repairs much more expensive than they would be had a tenant been there to help you nip it in the bud.
  • Vacant properties are more vulnerable to burglary and theft

Naturally, you’ll want to carry insurance on your Real Estate IRA investment – normally the standard landlord insurance policy for a property of similar size, type, value and number of units works fine.

But these standard insurance policies are not designed to cover the additional risks posed by a wholly vacant property. They are generally priced with your locality’s typical vacancy rates in mind. If your property has been vacant for more than a few months, and you have a claim, and your insurer finds out, they have grounds not to pay the claim.

That’s why insurance experts recommend owners of vacant properties purchase specialized vacant property coverage. You can buy this as a stand-alone policy, but it’s more commonly sold as a rider or additional feature or benefit of a standard landlords’ insurance policy.

The premiums are slightly higher than you would normally see on an off-the-shelf landlords’ policy, at any given deductible and coinsurance level. But the coverage is probably worth it, as it helps to plug a hole in your insurance protection plan that could result in devastating liability.

Note that just because your investment property is unoccupied doesn’t mean that it’s a vacant property for insurance purposes. The law expects and anticipates that landlords will have occasional vacancies of a few days or weeks between tenants, and during repairs and upgrades.

Many carriers will let you choose between a 3 month, 6-month or 12-month policy term. The best term for you probably reflects the length of time you may need to complete a repair or upgrade.

Premises liability coverage is usually optional, but is often a good idea because liability may be one of the biggest hazards to your IRA.

If you are doing upgrades or repairs, you may also consider purchasing builders risk insurance, which protects construction material and the value of those repairs and upgrades.

Motel, Hotel and Real Estate IRA vs. a REIT

A well-located and well-run hotel is a proven moneymaker. Paris Hilton didn’t get all those designer handbags because her family was broke! Like most real estate investments, hotels and motels provide a combination of regular income with the potential for capital appreciation. While lodging businesses are more labor and resource intensive compared to traditional residential landlording, they also provide more revenue opportunities, such as vending, restaurant leasing, event hosting, banqueting, catering and advertising, to name a few. And it’s perfectly legal to own them within a Real Estate IRA.

REITs vs. a Real Estate IRA

If you like REITs, you should love Real Estate IRAs, if you’re a long-term investor. Many investors are attracted to owning real estate  within a REIT, or real estate investment trust, because of the tax efficiency. The problem with owning a straight C corporation is taxation: Dividends are not tax deductible to the corporation. So the C corporation owner pays taxes at the high corporate level, and then has to pay them again as ordinary personal income when he or she receives income from the underlying properties. That’s a tax double whammy.

The advantage of a REIT is that as long as the REIT pays out at least 90 percent of its revenues as dividends, and as long as the company maintains at least 75 percent of its portfolio in real estate and receives at least 75 percent of its income from real estate. If all three requirements are met, then the REIT does not pay tax at the corporation level. Everything flows through to the individual tax return, and you pay tax on the income, though you can still qualify for capital gains rates when you sell REIT shares at a profit.

That’s a big tax efficiency improvement compared to C corporations. But if you are tax sensitive, or if you are in a high-income tax bracket but you still want income, then consider direct ownership of real estate within a Real Estate IRA.

With a Real Estate IRA, all income from rents is tax deferred, as are all capital gains. This is true as long as the assets remain in the account. If you own the property within a Roth IRA, then all income and all capital gains are tax free, provided the money stays in the Roth account for at least five years.

While many investors choose to gain exposure to the real estate/lodging asset class via owning a REIT, or even a REIT mutual fund, skilled investors may do even better owning hotels, motels or other lodging businesses more directly within their own IRAs.

One key advantage: Investors who purchase properties directly, rather than relying on the stock market, are often able to buy at deep discounts relative to future cash flows. By avoiding a liquidity premium and a large company premium, and judiciously employing leverage, income-focused investors can frequently get a superior income on invested capital.

Before you make the leap, remember that you must obey certain rules when it comes to owning a lodging business within an IRA:

You cannot hire your spouse, children or grandchildren as staff (nephews and siblings are ok under current law). You also cannot hire them to do contracted work such as management, catering or landscaping. The same goes for your parents, your spouse’s parents and any entities they own. Otherwise you could violate prohibited transaction rules.

Furthermore, you can’t rent or lease space to yourself, nor any of the individuals mentioned above. You can’t let them stay in your property, even if they pay a fair market rent, and you cannot stay overnight in your own property. You also cannot pay yourself a salary for running the hotel on a day-to-day basis, or you could violate self-dealing rules. Doing so will likely violate

Do not mingle personal and investment funds. You can’t even stop at the market on the way to check on your policy and pick up a few light bulbs for your own property using your own checkbook or debit card. All purchases and contracts associated with your Real Estate IRA property must be paid using money from that IRA.

Hotels and motels can be liability-generating businesses, so it’s important to maintain liability, umbrella and other essential forms of insurance coverage, and to hold the property within an entity that walls it off not only form your own personal assets but from other assets held within your retirement account.

Those are the basics of owning hotels and motels within a Real Estate IRA. More information on hotel and motel purchase and ownership within a Real Estate IRA in an upcoming post.

Real Estate IRA – Fire Insurance Claim Tips

Fires are among the most costly perils in the home insurance business. When you take out a fire insurance policy on a property you own within a Real Estate IRA, you are protecting yourself against a hazard that cost insurance companies, on average, nearly $40,000 per claim.

Sure, none of us like paying insurance premiums. But when you look at the potential costs of a fire if your Real Estate IRA owned properties aren’t insured, those premiums begin looking a lot more reasonable.

Assess smoke damage. Just because your Real Estate IRA property didn’t burn doesn’t mean it wasn’t damaged. Smoke can cause damage to a home, resulting in a claim against your fire insurance policy. You may have to replace drywall, carpeting, wallpaper, drapes, do a major paint job, and undertake a number of other repairs just from smoke damage alone. Be sure to document this damage thoroughly.

Further, cleaning your own home after a fire or major smoke event is unsafe. You will likely need professional cleaning and mitigation. Professional clean-up firms bring special protective equipment, like hepafilter masks and special vacuums to protect their workers from harmful fumes, soot and other hazardous particulates. So ensure you are prepared to support your claim for compensation for these significant expenses.

Furthermore, some do-it-yourself repair attempts backfire, making stains and other damage worse, not better!

Document early and document everything. At a minimum, keep records of the following:

  • Date of damage or loss
  • Type of damage (smoke, flame, water damage from firefighting efforts, etc.)
  • Description of damage.
  • Injuries, if any
  • Identities of all parties involved
  • Condition of the Real Estate IRA property or home at the time of the fire
  • Description of any temporary repairs you made
  • Cost of temporary repairs (include estimates and receipts
  • Police or fire department reports
  • Insurance claim ID number
  • Insurance company authorizations for any temporary repairs you do

Additionally, it may be a good idea to insist the tenants living in your Real Estate IRA own renter’s insurance. While your insurance policies will cover damage to your property, including interior and exterior damage, it won’t cover your tenants’ belongings. Furthermore, since renter’s insurance also has liability protection for your tenants, it helps protect you against any damages your tenants may cause, such as accidental kitchen fires, etc.

Some additional tips:

  • Don’t throw away damaged property before the insurance adjustor sees it.
  • Hire only licensed and ensured contractors to do repairs. Ask for certificates of insurance before starting any work.
  • Don’t sign documents allowing the contractor to collect payments directly from the insurance company. While the practice is legal, in reality the consumer almost never benefits.
  • Consider filing claims for loss of use of your property, or loss of rental income while the Real Estate IRA property is uninhabitable. Your landlord insurance policy may provide coverage against this loss.
  • Ask for an advance against your final insurance claim. This advance can help you pay for needed mitigations and to help prevent further damage, such as wet rot and mold from accumulated water from firefighting attempts.

Protecting Real Estate IRA Properties from Wildfire Risk

This month’s devastating fires in Northern California are heartbreaking to behold. As of this writing, fires in Santa Rosa and surrounding areas have taken the lives of at least 15 people and destroyed some 1,500 structures within just 12 hours. Hundreds of homes have been totally destroyed, as have a number of vineyards and wineries as at least 115,000 acres have gone up in flames. Thousands have been forced to evacuate.

Real Estate IRA investors need to take steps to protect their investments (and their tenants) against the risk of wildfires. Here are some actions you or your property manager can take to lessen risk to your retirement security and more importantly, safeguard the lives of your tenants.

  • Create a defensible space around the Real Estate IRA This means eliminating possible fuel that wildfires can consume while beating a path for your property. In practice, this means clearing space at least 100 feet away from your home and other flammable structures. This defensible space is what officials at the National Fire Protection Association call the “home ignition zone.” If fire penetrates this zone, the house is likely to go next.
  • Obey evacuation orders from authorities and insist that your tenants do the same.
  • Keep the lawn mower short, especially during the summer and fall wildfire seasons for most of the country.
  • Remove lawn cuttings and other foliage debris as soon as you cut it. Don’t let dead leaves and dry cut grass pile up.
  • Trim or remove trees near the house. Eliminate dry or dead foliage. Prune branches so that none are hanging below 6 to 10 feet from the ground.
  • Clear debris from roofs, yards and gutters
  • Pull dead vegetation and other junk out from under decks. Don’t store anything under decks.
  • Clear dead vegetation and other fuel sources from within 10 feet of the home.
  • Check your roof tiles. Are any missing? Replace them. These tiles are crucial to fending off burning embers.
  • Install wire mesh in all vents – not more than 1/8th of an inch.
  • Contact your landlord’s insurance or fire insurance carrier. Some companies have teams of people that will visit your property and provide a fire risk assessment free of charge. Sometimes they will apply a fire-resistant spray coating to key areas of the home.
  • If your insurance company does not offer the site assessment service, contact firewise.org/riskassessment to arrange one.
  • Replace mulched areas with “hardscaping.” Emphasize landscape ideas using gravel, rock and stone, rather than plants. It’s lower-maintenance anyway, once you get it in place. At a minimum, get mulch and plantings at least five feet away from the foundation.
  • Coordinate fire prevention and mitigation efforts with neighbors. The more steps your neighbors take to protect their properties, the safer your properties are, too.
  • Invest in fireproof or fire-retardant materials in all your Real Estate IRA
  • If you have plantings, use low-flammability plants.
  • Don’t stack firewood against the house.
  • Separate grasses, shrubs and trees near your home, to prevent a ‘fire ladder effect’ that can quickly transport flames to your roof.
  • Paint your street number clearly on the curb and prominently on your mailbox as well as on your home.
  • Invest in fire-resistant windows. Windows are a vital defense to fires. If a window breaks, embers can enter the home and quickly ignite flammable belongings inside like drapes and blankets.
  • Sign up for automated emergency notifications. Your homeowner’s and landlord’s insurance agent can help with this.
  • Check and double-check smoke and fire alarms in your Real Estate IRA
  • Conduct an occasional check on your property to ensure tenants aren’t creating fire hazards.

October is the Best Month for Real Estate IRA Owners to Buy Properties

April is the cruelest month, wrote T.S. Eliot in his poem “The Wasteland.” But the best time for a Real Estate IRA investor to buy a home might be October.

That’s according to a study by RealtyTrac, a real estate industry research and data firm. The company looked at some 32 million single family home sales and condominium sales since the year 2000. From all that data, they found that October was the best month of the year for Real Estate IRA and other buyers to be able find deals at a discount from the full market value of the property.

According to RealtyTrac’s research, October buyers were able to close deals at an average 2.6 percent discount from the estimated full market value of the property. February came in 2nd, at an average discount of 2.4 percent, followed by July, during which buyers would score an average discount of 2.3 percent, and then December, when discounts from estimated full market value amounted to 2.2 percent.

For Real Estate IRA investors, this can make a significant difference in long-term ROIs.

The worst month for Real Estate IRA Buyers

Nationally, the worst month, by far, when buyers had to pay a 1.2 percent premium to estimated full market value, was April. In fact, April was the only month during which buyers tended to pay a premium compared to the estimated full market value of the property.

So maybe T.S. Eliot was right after all.

It also appears that the National Association of Realtors overstates property values by about 2 percent.

“The start of the school year and the holidays influence our buyer decisions and serve as a strategic indicator of the most advantageous times for buyers to land their lowest-priced deal.  Due to less buyer competition, October and November typically provide a dip in the SoCal real estate activity cycle,” said Mark Hughes, chief operating officer with First Team Real Estate, a California based agency, to RealtyTrac researchers. In his Southern California market, the best day to buy at a discount is October 1st.

There are, of course, significant seasonal factors in play, and these seasonal factors can vary widely by region and with the local economy. In Seattle, for instance, the best day for buyers to get a discount is April 1st, when days are still quite short.

The best single day of the year to buy? October 8th, on which buyers paid an average of 10.8 percent below estimated market value at the time of the sale. Next was November 26th, when buyers paid 10.6 percent below market value as estimated by RealtyTrac at the time of the sale, followed by December 31st, when buyers paid an average of 9.7 percent below market value.

The worst day to buy? January 19th. Buyers paid an average of 9.6 more than the estimated value of the property in those markets.

That said, there’s lots of noise in the data, and the best day and month for various markets can vary widely.

In the Charlotte area, the best single day for buyers to pull the trigger is October 15th. In Raleigh, it’s July 5th. In Greensboro-High Point it’s December 5th. And in Charleston it’s December 6th. Columbia’s best day for buyers was February 7th, Augusta-Richmond County’s best day for buyers was February 16th. Raleigh’s is July 5th.

Real Estate IRA Investors: Protect Yourself Against Losses From Sinkholes

Real Estate IRA investing is a proven way to build long-term retirement wealth, for investors with substantial risk tolerance and a long enough time horizon. But you also want to avoid throwing your retirement wealth down a hole… literally… if a sinkhole should open up underneath your investment property.

This is a very real concern for Real Estate IRA investors in certain parts of the country – particularly in Florida, where thousands of sinkholes pockmark much of Hillsborough county around Tampa, and throughout much of the middle of the state. The most dangerous counties for sinkholes are Hillsborough, Pinellas, Miami-Dade and Broward counties.

A 2010 study by the Florida Office of Insurance Regulation found that sinkholes cost insurers and landlords/homeowners $409 million in Florida in 2009 alone – and sinkhole activity has been on the rise.

It’s not covered by a standard HO-3 or landlord’s insurance policy, though. Like earthquakes floods and hurricanes, sinkholes require specific insurance product that are offered separately from standard homeowners insurance and landlord’s insurance policies.

Florida Real Estate IRA owners can buy insurance

Fortunately, Florida Real Estate IRA owners can generally purchase insurance protection against most sinkholes that directly affect the building and property. Florida law requires all insurers selling property insurance in the state to offer coverage against “catastrophic ground cover collapse.”

However, confusion frequently arises because under Florida law, “sinkholes” and “catastrophic ground cover collapse” are different things.

Definitions matter in the insurance world. In Florida, a sinkhole is defined as a “landform created by subsidence of soil, sediment, or rock as underlying strata are dissolved by groundwater. A sinkhole may form by collapse into subterranean voids created by dissolution of limestone or dolostone or by subsidence as these strata are dissolved.”

For the hole to qualify as a catastrophic ground cover collapse, and thereby qualify for coverage, the following circumstances must apply:

  • The collapse of ground cover must be
  • The depression in ground cover must be clearly visible to the naked eye.
  • There must be structural damage to the building.
  • The damage must be so severe that the insured structure has been condemned and inhabitants ordered to vacate the dwelling by a lawful authority in that jurisdiction.

This definition excludes many incidents. For example, if the sinkhole appears very gradually, or if it requires engineering instruments to detect the ground movement, or if the sinkhole is in the yard and has not damaged the structure, the policy may not pay benefits.

To protect yourself, consider specialized sinkhole insurance. These policies, available as a rider or add-on to your standard landlord insurance policy, may provide much broader protection. Sinkhole insurance may also pay benefits to reimburse you for damage to outlying property, business and personal belongings lost to the sinkhole. Policies may also pay benefits to pay for sinkhole remediation, such as structural bracing, designed to keep buildings from suffering further damage.

Again, all businesses licensed to sell property insurance on homes in Florida are required by law to offer sinkhole insurance, but you must buy it separately. It does not come with a basic landlord’s policy.

The average sinkhole related insurance claim is over $100,000.

Tip: Real Estate IRA investors should ensure that the beneficiary of any sinkhole insurance policy is the IRA itself – not you, the owner. If you list yourself as the beneficiary, personally, you could run afoul of prohibited transaction laws and face big taxes and penalties.

If you’re buying a home where sinkholes are common – which includes not only Florida but also Tennessee, Kentucky and Pennsylvania – it may be worth it to have the property tested for sinkhole activity prior to signing the purchase contract, as part of your due diligence.

Hiring Contractors for Your Real Estate IRA Property

Real estate held within a Real Estate IRA is no different than real estate held elsewhere.

Most of the same general principles that are applicable to any other real estate investment apply to Real Estate IRA properties, including contractor selection and hiring. This piece will deal primarily with the specific issues that apply to Real Estate IRAs (as well as real estate investments held within self-directed 401(k)s, SEPs, SIMPLE IRAs and other tax-advantaged accounts).

  • Observe prohibited transaction rules. When you own a Real Estate IRA, there are certain restrictions on whom you can bring on as a contractor to help fix, repair or renovate your Real Estate IRA First of all, you cannot hire yourself. You cannot work for direct compensation or salary in any capacity in your Real Estate IRA. The IRS enforces very strict laws that prohibit you from using your Real Estate IRA to transact directly with yourself, your spouse, your children, grandchildren, parents or grandparents or those of your spouse, as well as any advisor who works with you on your Real Estate IRA in a fiduciary capacity. The same goes for any corporation or other business entity they control.

Simply put means you may be able to hire your brother to do the drywall, but not your son-in-law. And you can hire your brother-in-law’s landscaping company, but not your son.

Don’t try to pay yourself a salary for overseeing or managing your property held within a Real Estate IRA. You can do general management work without compensation, other than the eventual increase in value of the property. But you cannot take a salary, or the IRS could disqualify some or all of your IRA account, force you to take an immediate distribution, and then you’ll have to pay potential taxes and penalties on everything you take out.

The best way to select contractors is to use an arm’s length bidding process to find the best value, while disqualifying prohibited individuals.

  • Do not mingle personal and Real Estate IRA The second principle is you must keep personal and IRA accounts strictly segregated. If you hire a vendor or contractor to help repair your Real Estate IRA property, you must make all payments solely with money from within the IRA account. This means you must make these payments only with money that you rolled over to the account, contributed to the account directly, or with profits generated from within the Real Estate IRA.

Naturally, like any property owner, you should use only properly licensed and bonded contractors, and verify that each contractor who sets foot on your property carries important insurance coverage like worker’s compensation insurance and/or construction defect insurance. Failure to do so exposes your Real Estate IRA to tremendous potential risk.