Add a House to Your IRA

But this real estate play can be complex--and costly

If you've been itching to invest in property but have held back because you're short of cash, you might be overlooking a bundle right under your nose: your individual retirement account. Many don't realize they can use money in an IRA to buy real estate instead of mutual funds, stocks, or bonds. "You can't put anything but cash [directly] into an IRA," says Internal Revenue Service spokesman Don Roberts, "but once you have the cash inthere is no prohibition on purchasing investment property with it."

This strategy isn't for everyone: It can be complex, costly, and require the help of a tax adviser. But if done right, it can be a smart investment. Jim Maxwell, owner of a Ridgefield (Wash.) business that arranges tax-favored real estate deals, has gone this route himself, using $70,000 of his IRA assets in 1999 to buy five acres of prime development land he says is now worth $125,000.

One benefit to acquiring real estate through an IRA is that if you sell at a profit, you can postpone or totally avoid paying taxes on the gains. If you make the transactions through a tax-deductible IRA, you'll pay ordinary income tax when you start taking money out after age 59 1/2. Chances are you'll be retired and your tax bracket will be lower at that point than it was at the peak of your career. Even better, you'll escape tax altogether if you buy the property in a Roth IRA and hold it for at least five years before selling.

Don't rush out to buy that two-family house. The IRS doesn't let you hold your own residence in your IRA, nor can anyone in your immediate family live on the property. But you could buy a home with the intention of moving into it in the future, says Debra Greenstein, president of Entrust Administration, an IRA custodian company in Oakland, Calif. The transaction would need Labor Dept. approval and rack up some $3,500 in fees.

HIRED HELP. Costs can add up, because you'll need to pay for help to make the purchase, oversee the account, and--if you acquire a building with tenants--handle the management. The IRA should also have enough cash to pay for mortgage, taxes, and other related expenses. Yet if you put in more than the annual limit of $3,000 in 2002 ($3,500 for those 50 and older) to pay the bills, the IRS will impose a 6% penalty on your excess contribution. Keeping six months of mortgage payments in the IRA provides a comfortable cushion.

Another wrinkle can occur when you turn 70 1/2, when you're required to start withdrawals. The distribution amount depends on your age and the fair market value of your IRA's assets. If your account lacks the cash to meet the withdrawal requirement, you'll have to sell the property--even if the market is down. Finally, Hugh Bromma, CEO of Entrust, says unless you plan the purchase and sale carefully, you could be hit with the "unrelated business tax" of 39.6%. Consult a tax expert.

The real estate play wouldn't suit those who need to keep an IRA liquid. But if that's not an issue, the strategy gives stock-shy investors a chance to participate in a very desirable market.

By Ellen Hoffman

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