My last few blogs have been examples of how you can invest in real estate through a self-directed Individual Retirement Account. I thought I would take a few minutes to share an example of what NOT to do with your
IRA. A client purchased a beach house in Florida through his self-directed IRA. He purchased it in the name of his IRA and directed his IRA custodian to sign all the paperwork on behalf of the IRA. He made repairs to the property and made sure to hire a contractor and pay for everything out of his IRA.
He decided to turn the house into a beach rental property and began renting it out to people vacationing in the area. All the profits from the rental income went straight back into his IRA. He was doing everything right, but then made one huge mistake. The client took his family to Florida for a week and stayed in the rental house owned by his self-directed IRA. He paid his IRA the normal going rate for the rental and even wrote himself a receipt.
About a year later his IRA was audited by the IRS. The auditor came across the client’s name as a guest at the rental house and the client explained that his family had stayed there, but they paid the normal rental rate. Despite the fact that he paid rent for staying there and kept a record of it, it is still considered a prohibited transaction to use or benefit personally from anything owned by your IRA. The client’s IRA was disallowed and he was forced to pay taxes and penalties on all the cash and assets held by the account.
When using a self-directed IRA be sure you know the rules detailed in IRC 4975 that deal with disqualified parties and prohibited transactions. Breaking these rules knowingly or even inadvertently can have severe consequences.