Q. I'd like to buy real estate through my Individual Retirement Account. Can you tell me how to do so?
A. Contrary to what some people believe, it is possible to invest in apartment buildings, homes, raw land and other properties through an IRA.
The misconception may stem from the visibility of companies that offer the type of retirement vehicles — known as self-directed IRAs — that allow you to invest in real estate. With the exception of a firm opening here by the end of the month, there are only a few Mainland trust companies and other firms that handle these.
But before I go further, you should know there are certain types of real estate transactions that are prohibited by the Internal Revenue Service rules on IRAs. You can't buy a home with your IRA and live in it.
Selling a property to your IRA is prohibited as is managing a property you've bought as an investment. These bans apply to your family members as well.
Other than that, your property purchases are pretty much unrestricted, including buying real estate in foreign countries. Self-directed IRAs can also be used for a mind-numbing array of investments, including oil wells, private funds, start-up companies and mortgages.
About the only things not allowed (in addition to certain real estate deals mentioned above) include collectibles and life insurance.
Setting up a self-directed IRA (or Roth IRA, SEP/IRA, Educational Savings Account and other pension plan rollover accounts) typically involves rolling over or transferring an existing IRA or 401(k) to a company that administers or acts as a custodian for self-directed IRAs. You can also set up one by funding it with your annual IRA contributions.
At San Francisco-based Pensco Trust Co., setting up such an IRA involves filling out a two-page application that can be downloaded off the Web and mailed into the company.
"It's actually simpler than people think," said Heather Anderson, senior marketing manager. "A typical response is this seems too easy."
From there the buying of real estate follows pretty much along the path of other purchases with the exception of the IRA custodian or administrators' involvement and the filing of a few more documents.
After finding an investment property, an individual submits an offer with the IRA listed as the buyer. If accepted, Pensco will fund a deposit after receiving paperwork from the IRA beneficiary.
The property then will be purchased by the IRA, which holds title to the property.
While many people pay for properties entirely with IRA funds, there is a group that seeks higher profits by using the IRAs to provide downpayments and getting loans for the rest of the purchase, Anderson said. The loans typically require buyers to put down a substantial portion of the purchase price and come with high interest rates.
The tax rules get a little complicated when using loans for purchases, with the possibility of income taxes and capital gains taxes being levied on proceeds from the financed portion of the property. You'll want to consult with a professional advisor such as a Certified Public Accountant to get their views on self-directed IRAs and possible tax consequences.
Tracy Stice, who is opening the Hawai'i franchise of Entrust Group this month, also recommended people get a property manager for the real estate investments. Otherwise people run the risk of having their IRA disqualified by the Internal Revenue Service under the prohibited transaction rules. Entrust is a third-party administrator of self-directed IRAs.
He said investors also need to be mindful of IRA rules that require minimum payouts once individuals reach age 70 and a half. That may force some people to sell all or a portion of the properties at that time. People may also take a portion of they property in their own name in lieu of a payout, becoming a joint owner of the property with the IRA, Pensco's Anderson said.
Fees vary for the services provided by administrators and custodians. Anderson said her company charges $50 to set up an account, $100 per U.S. real estate transaction and an annual fee of as much as 0.0035 percent of asset value. That works out to $350 on a $100,000 account.
Entrust has two options for fees, including one based on the number of assets held in the IRA. Its fees based on market value include a $50 expense to set up an account. An $100,000 IRA would be charged 0.0055 of value, or $550 a year for record keeping. There are other fees, including a $95 expense for buying or selling an investment.
Do you have a question about personal finance, taxes or other money matters? Reach Akamai Money columnist Greg Wiles at 525-8088 or email@example.com