It never fails. Cold winters up North bring cause lots of clients to think
about retirement in the sun. They come
to our doors in search of ways to use their retirement accounts to purchase
resort property in the warm areas of the globe.
Maui, Florida, Phoenix, even British Honduras are all the stuff of
dreams when thinking about retiring somewhere winter never visits.
There are many clients that want to use their IRA/401(k)
accounts for purchasing the “dream retirement home”. Is this possible? It certainly is, within certain
boundaries. What does the IRS code say
about buying retirement property in your IRA?
The answer is nothing. The IRS
does not endorse nor recommend any investment to be purchased by your IRA. The rules prohibit only two classes of
investment: Life insurance and
collectibles. The code also requires that the money be used for investment. The other rules governing
investments deal with who you deal with and how the investment is used. For a client purchasing a property for potential future retirement, we always point out the following:
- When
you take the property out of your plan or “distribute” it for your
personal use, you will be taxed on the fair market value of the property
- You
must be over 59 ½ years of age or you will pay a 10% penalty as well as
the taxes due.
- No
personal use is allowed by you or by any disqualified person* while it is
in your IRA
- All
expenses of the purchase and maintenance must be paid entirely by your IRA
while it is in the IRA
- You
may rent it out but all monies must go back to the IRA
- You must have a plan for the ultimate distribution of the property from your IRA should you wish to use it upon retirement
Are you still interested at this point? The questions are “how to buy it in the IRA”
and “what to do when you retire and want to use it” should be answered before
plunging into the “retirement home purchase” scenario. The services of a qualified tax professional
may be necessary in order to determine what the tax burden will be upon
retirement as there needs to be some strategy for paying taxes on the property
distributed from your IRA. The other important part of this scenario is that you need a self directed IRA with an administrator that is comfortable with real estate purchases.
There are two major ways to approach this problem, although
there may be some variations. Consider
the first case:
Bob and Frannie by a condo in Maui.
On vacation in West Maui, Bob and Frannie decide to purchase
a home on the hill above Kahana.
Formerly pineapple fields, the developer took advantage of the great
ocean views and created a subdivision close to the West Maui airport and Lahina
that retired people just love. Although
Bob and Frannie are only in their early 40’s, they did not want to miss out on
the opportunity to get in on the ground floor of something now, thinking they
may not be able to afford it in the future.
The cost of the property was $350,000. Bob had an IRA that was approximately
$250,000 resulting from his severance from a company layoff. Frannie had about $100,000 in her IRA from
the same company and the money was invested in a mutual fund after distribution
from the company 401(k) plan. Neither
Bob nor Frannie had any great plans to make this money work harder but the idea
of property in Maui was just too good to walk away from. With the help of a self directed IRA
administrator and a semi-knowledgeable real estate broker they managed to close
on the property, title held in the name of the two self directed IRAs: Bob’s IRA with a 71% undivided interest and
Frannies’ IRA owning the remaining 29%.
The property was placed on a short term rental program in order that the
IRA would have cash to pay for the real estate taxes, maintenance and HOA
dues. The property may not be used by
Bob and Frannie while it is still in their plan.
In the future the property may either be taken completely out of the IRAs as one large in-kind distribution or could be taken out incrementally over a period of years to lessen the immediate tax burden. This strategy is a subject unto itself but it has been done. A few parting thoughts on this: 1) a self directed Roth IRA would allow distribution after 59.5 years of age without tax consequences and 2) the IRS requires that when you turn 70.5 years of age you MUST take distributions from a traditional IRA.
