After several years of record-breaking prices and sales, the U.S. housing market is dramatically cooling off. Many homes have been on the market for longer periods of time, and many owners of those properties have reduced their asking prices. The market slowdown creates a tempting opportunity for investors thinking of buying properties at lower prices and holding them until the market rebounds.
Some investors with a high tolerance of risk might even consider a little-known strategy that allows real estate to be purchased with individual retirement account (IRA) dollars.
Real estate assets that are purchased with IRAs are bought through a self-directed plan. However, Internal Revenue Service rules state that real estate owned by IRAs must be overseen by a custodian, not by the IRA owner.
Local IRA and retirement advisors say that although they can advise clients when they’re setting up a self-directed IRA, they do not offer custodian services. Instead, they will refer clients to other firms that offer those services. Milwaukee-area investors who want to invest self-directed IRA dollars in real estate need to contract with out-of-town custodians.
Millennium Trust Co. LLC, a Chicago-based independent trust company and leading provider of administrative and custody services, offers services including administration of
self-directed IRAs that hold real estate within their portfolios, said Gene Meeker, senior vice president of alternative investment services.
The housing boom of recent years spurred increased interest in investing IRA dollars in real estate, Meeker said.
“The thing is, investors have a comfort level with real estate,” he said. “And there’s increasing interest in this. It’s starting to catch fire, as people are finding out about it.”
Meeker said his company routinely tells potential clients to spend time talking with their financial advisors to determine if investing in real estate with IRA dollars is truly best for them.
“It’s not for everybody,” Meeker said. “There’s risk involved. You need to know what you’re doing, and you need to know the different types of real estate you could be involved in. We’re not financial advisors, but people need to make (real estate investment) part of their overall asset allocation and not put everything they own into real estate. People are well-advised to talk to an accountant, attorney and financial consultant. But when they hear about it, they’ve very willing and able to talk to us.”
Although local investment advisors and managers don’t offer custodial services for self-directed IRAs, some say they are often asked about investing in real estate with IRA dollars.
“People ask about it, but very few follow through with it,” said Joe Ackley, vice president of retirement plan services for Associated Trust Co., a division of Green Bay-based Associated Bank. Ackley said many potential real estate investors shy away because of the complexity involved. For instance, the property cannot be used by the investor or a direct family member as either a residence or vacation site, Ackley said.
Under rules governing IRAs, investors are not allowed to live in, collect rent on, pay taxes or generally have anything to do with their investment properties. Instead, a custodian needs to handle all of the affairs of the property, per the direction of the investor.
Property owners can be subject to Internal Revenue Service penalties and fines, Ackley said, if they are found in violation of those rules.
“Your entire IRA could become disqualified and taxed,” he said. “It’s so easy (to happen). It’s very easy to blow this thing up.”
The IRA that owns the property also needs to have enough cash assets to pay all taxes, fees, annual appraisals and other expenses for the property. IRS rules and regulations do not allow the IRA policy owner to pay those fees from their own pockets without penalties, Ackley and Meeker said.
Dean Muller, vice president, financial advisor and senior consultant with the Wauwatosa office of New York-based Morgan Stanley, said he’s had several clients ask about investing in real estate with IRA dollars, but hasn’t had any follow through. He said there are other easier methods to invest in real estate without buying specific properties within an IRA.
“REITs (real estate investment trusts) are a very liquid way of investing,” Muller said. “With a REIT, you can get in and out very easily. And there are enough of them out there that you should be able to find one that does what you want.”
Real estate itself is not a bad investment vehicle, Muller said, but investing in it via a self-directed IRA might not be his first choice.
“I believe in real estate, but I believe that people are looking for less complexity (in investing) not more,” he said.
Despite the complexity and recent downturn in the residential real estate market, Meeker’s company is planning under the assumption that there will be continued interest in owning property – residential, commercial, industrial and other types – through IRA assets.
“We’re networking with a lot of professionals in that sphere – developers, mortgage brokers, real estate attorneys, financial planners and CPAs,” he said. “We’re getting the word out there.”
