Rolling Over A 401(K) Into An IRA to Buy Real Estate

Your retirement accounts can invest in more than stocks and bonds—a Self Directed IRA can also buy real estate.

As you read this article, you may initially think that this process seems a little complicated. Actually, once an accountant and Realtor have guided you through the purchase of your first property, you’ll realize the process is relatively simple and straightforward.

Let’s go over what you need to do to be able to use your IRA to purchase property.

First, you need a Self Directed IRA fund. As the name implies, all investment decisions using your IRA are made by you, instead of the IRA holder. But while you make all the decisions, you need a custodian to make investments on your behalf.

Custodians are companies that manage the transaction, the paperwork and the reporting. Be aware that custodians charge fees related to administrative and reporting purposes, and they don’t give direct advice.

You aren’t limited to buying a house with your Self Directed IRA. Some additional investments include the following:

• Vacant lots
• Parking lots
• Mobile homes
• Apartments
• Multi-family buildings
• Boat slips

Until you retire, any investment property you purchase can’t be used as your primary, secondary, or vacation residence. After retirement, you can live in the property. This means that neither you nor your immediate family can benefit from this investment before you reach the IRA’s distribution age. If you do, you may be slapped with a tax penalty and could have your IRA invalidated.

Everything you use to fund and maintain an IRA investment property must come out of your IRA. Likewise, money that comes out of the investment property must be given back to your IRA. So if you buy a house and rent it out, that rent money must go back into your IRA—not your wallet.

Similarly, if your investment property requires repairs—like a new water heater—you need to use your IRA to pay for it. Keep in mind that you, as the investor, can’t be reimbursed for any work you do on the property.

Every penny in and out for the property must be approved by the IRA custodian. It might make sense to have a reputable property management company in place to navigate day-to-day duties.

When planning this purchase, be sure you have enough money in your IRA to cover taxes, association fees, emergencies, maintenance and any potential problems. If you don’t, you’ll have to make the maximum annual contribution and hope it’s enough.

The good news is that all income from the property is tax deferred. That includes rental income and capital gains. If you plan to be in a lower tax bracket at retirement, this is quite beneficial. You can also make tax deductible contributions to the IRA.

Rollovers

If you decide to do a rollover, any of the top mutual fund and brokerage firms will provide the necessary forms. And you may be able to complete the forms online.

When choosing a custodian for your IRA, ask about their fees. Historically, some firms have had relatively low costs.

Be aware that you should make a direct rollover. Do not send the money to yourself first. Why? Well, if you’ve don’t make a direct rollover, your employer (for your 401(k)) will need to withhold 20% in federal income taxes. In fact, there may even be a 10% early withdrawal penalty (if you are under age 55.)

Once your money is in an IRA, you get some nice tax benefits. The earnings in the account — whether from dividends, interest or capital gains — will grow tax free. You will not have to pay Uncle Sam until you make withdrawals. Note that if you do make withdrawals before reaching age 59 ½, there will be a 10% penalty.

You can also make additional contributions to your IRA account, which may be tax deductible. If you’re under age 50, the maximum amount is $5,000 of earned income per year. Once you reach age 50, the maximum amount is $6,000 of earned income per year.

Note that it is also possible to rollover money into a Roth IRA. With this vehicle, your withdrawals are not subject to taxes. There are also no mandatory withdrawal requirements (a traditional IRA forces you to start taking your money out when you reach age 70 ½). However, in exchange for these benefits, the contributions are not deductible.

Deciding whether you should go with a traditional IRA versus a Roth IRA depends on your expected tax situation when you retire. Understand that if you do a Roth conversion, you will need to pay taxes on the rollover of your current retirement plan into the Roth IRA. Needless to say, calculating your income, credits, exemptions, and deductions is critical for this decision.

Because of the various rules and tax issues, it makes sense to seek out professional advice, especially from someone who understands the tax implications of rollovers.

Overview of Purchasing Property

Here is a general overview of the process of purchasing investment property with Self Directed IRA funds.

First, find a property with a professional Realtor.

Your Realtor will create the purchase agreement which is the offer on the property in the name of the Self Directed IRA and send that offer to your custodian.

• Transfer funds to a Self Directed IRA custodian.
• With your permission, your custodian will release funds for purchase - the purchase agreement does not constitute authority.
• Your Self Directed IRA custodian will sign at closing - you will own the deed.
• Your Self Directed IRA custodian will distribute the funds appropriately.
• You will make management decisions.
• The rental income and expenses will be handled within the Self Directed IRA.

Regulations For Real Estate Purchases Using Self Directed IRA’s                                                 

You can purchase real estate from anyone except the persons listed below.  You can lease to anyone except the persons listed below. Those listed below are considered disqualified.

• Your spouse
• Your descendants and spouses of descendants (children, sons-and daughters-in-law, grandchildren, etc.)
• Your parents, grandparents, or great-grandparents
• Anyone providing services to the IRA and their families
• Any company, trust, or partnership in which a disqualified person holds 50% or more interest or voting power
• Anyone involved in a position of responsibility related to the IRA custodianship

Note that your siblings are not considered disqualified persons. 

To learn more, get advice from an experienced Realtor as well as an accountant. Investors should also be familiar with the rules for the type of IRA they're using. Whether it is a Simple IRA, Roth or Traditional IRA, SEP or Solo 401(k), contribution limits still apply, and there are penalties for early withdrawals.

Become a well educated investor, and then decide if real estate should become part of your retirement account.

Disclaimer: This article is not intended to provide legal, tax or investment advice. Always seek professional advice from an accountant, Realtor, or a Self Directed IRA representative for more information as to how a using a Self Directed IRA to purchase property might benefit you.