Tom Kelly: Purchase real estate with a converted 401(k) plan

Investing in real estate individual retirement accounts has been available, legal and appropriate since 1974. Still, consumers attempting to nail down a piece of property with their IRA continue to hear “you can’t do that” from many accountants.

Not only are self-directed IRAs allowed by Section 408 of the Internal Revenue Code, but there are also a variety of ways to fund the account and transfer funds to a trustee or custodian specializing in real estate IRAs.

To prepare for your real estate IRA, designate the amount of your retirement funds that you wish to use in the property deal and open a new IRA account with an independent administrator. While some community banks will offer real estate IRAs to existing customers, few lenders want to deal with the time and managerial challenges.

Patrick Rice, the author of “IRA Wealth: Revolutionary IRA Strategies for Real Estate Investment,” said many consumers underestimate the possibilities 401(k) programs from previous jobs.

For example, let’s suppose you took the family on a rafting vacation and discovered a spot on the river that is for sale. You envision floating and fishing the river when you retire but you don’t have the money to even think about buying a retirement cabin. In fact, you are resigned to the fact that by the time you save the money necessary for the getaway, your pristine piece of the river will be far too expensive to afford.

However, you suddenly remember the 401(k) account you had with a previous employer. You can roll the 401(k) money to a new self-directed IRA and instruct the custodian to make the purchase of the riverfront parcel. You then keep the property in the IRA, tax deferred (tax-free if it’s a Roth IRA) until you retire. You can even rent it out to bring even more income to your IRA.

When you retire, the IRA will deed you the property. You will face a tax liability on the value (this is called a “distribution in kind”). Since your work load and income stream probably will be curtailed in retirement, you will pay lower taxes.

“Cash is king and always will be,” Rice said. “Sometimes, there’s no other means of acquiring property than with a retirement account. Real estate adds diversification and allows consumers to take advantage of ‘opportunity-now’ transactions.”

According to Rice, financial advisers often confuse the rules that apply to qualified retirement plans with those that regulate IRAs. Self-directed pension plans (including IRAs, Keoughs, and SEPs) are the most flexible of all retirement vehicles.

One of those rules that is often misapplied is the one regarding maximum contributions by retirement funds to limited partnerships. The guideline states that no more than 25 percent of a limited partnership can be funded by retirement funds. The IRA, however, does not have these limitations. The account holders of the self-directed IRAs have complete and total control over the investments they choose.

Your IRA cannot directly or indirectly buy real estate from a “disqualified person.” Who is a disqualified person?

• The IRA owner.
• The IRA owner’s spouse, descendant (e.g., son) or ascendant (e.g., mother).
• Spouse of a descendant of the IRA holder.
• A fiduciary of the IRA or person providing services to the IRA (e.g., the trustee or custodian).
• An entity at least 50 percent of which is owned (or at least 50 percent of the beneficial interests are held) by a combination of the above (e.g., if you and your spouse own 50 percent of an LLC, that LLC is a disqualified person with respect to your IRA).
• A 10 percent owner, officer or director or highly compensated employee of such an entity.

You cannot have your IRA enable an investment for yourself or another disqualified person. In other words, if the IRA’s investment is deemed essential to accomplishing a transaction in which both you and your IRA invest, then the transaction would be considered a prohibited transaction.

Your IRA cannot purchase a real estate asset and then have a disqualified person use it while it is in the IRA. For example, you cannot buy a vacation home and use it partly for personal use, even though you might rent it to unrelated persons the rest of the year.

So, if you have been wondering what to do with your old 401(k), why not look to real estate? You have more options than you think.