Holding real property in an IRA - the pros and cons.

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Whether an IRA holds real property or financial securities, there are similar rules that apply, such as lack of a stepped-up basis at death and lack of long-term capital gains tax treatment.  However,  there are numerous other drawbacks that apply to the holding of real estate:

  • Higher transaction costs\commissions for real property transactions (Five-six percent commissions, compared to transaction fees of $7-$35 for most financial instruments.
  • Lack of diversification (owning one-two properties versus thousands of stocks\bonds)
  • Far less liquidity.
  • RMD valuation appraisals may be required after age 70 ½ (unless held in a Roth IRA).
  • Administrative fees for real property are typically much higher than for financial instruments.
  • Greater necessary diligence whenever making a non-traditional IRA investment.

Let's take a look at the drawbacks to holding real property in a retirement account versus outside of it, as these drawbacks are significant as well:

  • Interest rates and down payments are likely to be higher, as the mortgage, if therre is one, must be a non-recourse loan.
  • If financed, income attributed to financing can result in unrelated business taxable income (UBIT)
  • There is no stepped-up basis upon the death of the account owner.
  • No long-term capital gains tax treatment.
  • No owner deduction for interest, depreciation, property tax, or other expenses.
  • Difficulty taking required minimum distributions after age 70 ½, unless there is available cash in the account.
  • May need an annual appraisal to determine annual mandatory distributions after age 70 1/12.
  • No personal use of the property is permitted.
  • Administrative fees apply.
  • Greater diligence is required to ensure that all relevant retirement account rules are followed in order to avoid disqualification of the IRA.

Given all of these issues, those contemplating real-estate related investments in an IRA may find it less problematic to invest in a publicly traded REITs, rather than have the IRA own real property, though REITs, like any investment, are not without their drawbacks as well.