Individual Retirement Accounts
(IRA) and Real Estate Investments
(March 28th, 2008)
Many savers have the idea that if they invest
their IRA savings into Real Estate, they will make good profits and
increase their retirement savings ultimately. However, there
are many pitfalls that could get you in trouble if you do not follow
the IRA rules.
Prohibited IRA Transactions
Some specific investments are prohibited
in IRAs. These investments are called "collectibles"
and include items such as:
-
Artwork
- Antiques
- Coins
- Collectible Stamps
- Gems
Real Estate is not prohibited, but certain rules and
pitfalls can easily make your IRA Real Estate Investment into a prohibited
transaction.
Prohibited Real Estate Transactions
- You can't sell property to your IRA, nor
buy property from your IRA
- You can't loan money to your IRA or borrow
money from it
- You can't use your IRA Savings as Loan Collateral
- You can't receive goods and services from
your IRA nor provide them from your IRA
Beware, some companies promote real estate
investments for IRAs by not properly disclosing all the related rules
and prohibitions as stated by the law. This is because they do
not want to lose business and you as a client/customer.
Examples of Prohibited Transactions
For example, imagine your IRA purchases a broken-down
house that needs lots of repair work and remodelling. You use funds from
your IRA to do the remodelling and add value to the house. Later,
you sell it at a profit. That is NOT a prohibited transaction yet. However,
if the remodelling is done by yourself, or your relative's local shop,
this means you are providing "services" to your IRA. Now THIS
is a prohibited transaction.
Another example of a prohibited transaction
is when you buy a rental property and also do the work of finding tenants,
collecting rent and property management. If you or your relatives
do this, you are providing services to your IRA.
So What If?
So what if you end up doing a prohibited IRA
transaction? If so, your IRA will be considered terminated as of January
1st of the current year (in which the prohibited transaction occured).
This also means:
- You would have to pay tax on your entire
IRA amount as if you're making a 100% withdrawal
- If you are lesser than 59.5 years old, you
will have to pay 10% early withdrawal penalty fee.
- You lose all the compounding interest and
benefits that you could receive from an IRA account over years of investing
and saving.
There haven't been many cases of individuals
using their IRA for Real Estate Investment, therefore the Internal Revenue
Service (IRS) is not very active in this matter. However, as
the current real estate bubble goes on, more people will get the idea
of investing their IRAs in real estate. As these types of investments
go up, the IRS will definitely become more active in this matter.
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Roth IRA Contribution Limits |
| Year |
Regular Contributions |
Catch Up Contributions |
| 2001 |
$2000 |
$0 |
| 2002 |
$3000 |
$500 |
| 2003 |
$3000 |
$500 |
| 2004 |
$3000 |
$500 |
| 2005 |
$4000 |
$500 |
| 2006 |
$4000 |
$1000 |
| 2007 |
$4000 |
$1000 |
| 2008 |
$5000 |
$1000 |
| 2009 |
$5500 |
$1000 |
|
Modified Adjusted Gross Income Limits
|
| Year |
Filing as Single |
Filing as Joint |
| 2001 |
$33,000 - $43,000 |
$53,000 - $63,000 |
| 2002 |
$34,000 - $44,000 |
$54,000 - $64,000 |
| 2003 |
$40,000 - $50,000 |
$60,000 - $70,000 |
| 2004 |
$45,000 - $55,000 |
$65,000 - $75,000 |
| 2005 |
$50,000 - $60,000 |
$70,000 - $80,000 |
| 2006 |
$50,000 - $60,000 |
$75,000 - $85,000 |
| 2007 |
$50,000 - $60,000 |
$80,000 - $100,000 |
|
Roth IRA Facts |
In Traditional IRA, the contributions you make towards the account
are not taxed. Whatever capital gains & earnings you make on
your IRA are also not taxed up until retirement, when you withdraw
money from your account. For example, imagine you made $50,000 this
year and contributed $5000 to a traditional IRA. You will be taxed
on $50,000 - $5000 = $45,000. Furthermore, your $5000 contribution
will grow tax-deferred for many years, until you retire and decide
to withdraw it.
Any 'qualified distributions'
you take from a Roth IRA will NOT be included in your taxable income,
hence making you exempt from paying taxes. You won't have to pay
taxes on the original principal you contributed nor any taxes on
capital gains & earnings you have accumulated. In order for
the distribution to be classified as 'qualified', it must be taken
under 1 of the following circumstances:
- the Roth IRA
investor must be 59 and 1/2 years or older at the time of the distribution
- the Roth IRA investor becomes disabled at the time of taking the
distributions
- the Roth IRA investor dies and his/her beneficiary receives the
assets contained in the plan
- the distributions taken from the Roth IRA will be used in the
purchase or building of a new home for the Roth IRA holder or qualified
family member. This is limited to $10,000 per person per lifetime.
Qualified family members include:
--> the Roth IRA investor
--> the Roth IRA investor's spouse
--> children of the Roth IRA investor
--> grandchildren of the Roth IRA investor
--> parent or ancestor of the Roth IRA investor
The law states that if your adjusted gross
income (AGI) is greater than $100,000, you cannot convert from a
traditional IRA to a Roth IRA. This law applies to both singles,
married filing joint & head of household filers. Note that if
you are filing a married-filing-separate tax return, you are not
eligible to convert a traditional IRA to a Roth IRA at all, no matter
what your adjusted gross income is. |
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