Volume 19 Issue 5 -- September/October 2007
Ms. Needa Lot (hereafter,
“Lot”) has $500,000 in her 401(k) and wants to buy real estate with the
funds. Can she? Possibly.
Should she? That’s not as
easy to answer. The conditional word “should” is pregnant with
complications, do’s, and don’t’s.
Many promoters of
non-traditional 401(k) and IRA investments, especially on the Internet, would
Even if they are permitted,
self-directed accounts (both IRA and 401(k)) present numerous hurdles that could
defeat the tax-free status of the account. Remember,
the U.S. Government wants retirement funds to be used for just that purpose,
typically occur in dealings with relatives and related businesses (businesses in
Even inadvertently engaging in a
prohibited transaction can lead to substantial excise taxes imposed on Lot’s
account as well as loss of tax-free status for the account and early
distribution penalties if
As most people know, the
investments of a qualified retirement plan are not subject to income taxation
until the proceeds are distributed. In
many qualified plans assets double every 10 years with interest at 7.2% and no
It would be a good idea for
When it comes time to take
mandatory distributions, it might also be necessary to have appraisals done on
the real property every year in order to ensure that the mandatory distributions
are in the correct amount. In
addition, if the investments are relatively illiquid (hard to sell), it may be
difficult to obtain the cash to make mandatory distributions.
Real estate purchased in an IRA
may lose some of the tax benefits of owning the real estate. For example,
improved real estate can be depreciated and for state and local taxes it can be
deducted, but since a retirement account is tax-exempt, there is no tax benefit
from the depreciation.
Real estate not in a retirement
plan, when sold, is taxed at capital gains tax rates, which currently are 15%.
Gains accumulating inside an IRA or 401(k), however, will be subject to ordinary
income tax rates when they are withdrawn by the retiree or the retiree’s
The choices in this area are not
easy to make. Some advisors say that
self-directed accounts are an accident waiting to happen. Others, particularly
those providing custodial services for such plans, argue to the contrary.
As with many choices, a lot depends on the background and ability of
Because there are no clear
answers in this area, we have tried to be impartial. If you have
questions about this issue, other than investment-type questions, give us
a call. We are not retirement plan specialists or advisors and we do not offer
investment or real estate advice.
By Tax and Business Professionals, Inc.
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Manassas, VA 20110
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