Tax Talk by George Saenz
Bankrate.com
Question
Dear Tax Talk,
My husband and I have several traditional IRAs. We heard that you can put them all together and create one account that can in turn buy a property in some kind of trust. I heard the term self-directed IRA. How can we do this?
-- Marietta
Answer
Dear Marietta,
While in theory it's true that you can invest in real estate using IRA funds, in practice it becomes difficult. If you want to use the money in your IRA to buy real estate, you'll have to find an IRA custodian that will allow this type of investment. Your bank and your broker won't, since they want you to invest in their products. It's also a more complex administration. The custodian fees in a self-directed IRA will be considerably higher than those that the bank or broker charge, especially for real estate. For example, the custodian will charge for handling transactions such as taking rent deposits and paying bills at anywhere from $5 to $25 per item.
In addition, you usually cannot have financed property in an IRA. This means you have to have enough funds in the IRA to go out and pay cash for the property. If you set up the IRA yourself, the account may only have enough funds to buy land. If you want to develop that land, you'll have to wait long enough to contribute more cash (due to the $4,000 annual limits) to pay for the construction, since you cannot finance.
Aside from losing leverage from financing, you're also converting long-term capital gains into ordinary income. If you hold property outside your IRA for more than one year, the maximum long-term capital gains tax rate is 15 percent. The maximum tax rate that applies to IRA withdrawals can easily be more than double the capital gains tax rate.
