Money Report: Investing outside the box

Money Report

Steven WeberThe majority of IRA account owners are invested in CDs, stocks, bonds, mutual funds and annuities, but it turns out these aren’t your only choices. If properly handled, nontraditional retirement investments (NTIs) such as limited partnerships, private placements, trust deeds/notes and real estate can be legally held in IRAs and certain retirement accounts.

Real estate is the most popular non-traditional investment for IRAs, although many of the investment advantages of owning real estate are not available or applicable when real estate is held in an IRA. Also, it is possible to get real estate diversification simply by purchasing publicly traded real estate investment trusts, or the mutual or exchange traded funds that invest in them.

But some investors aren’t only interested in diversification, but holding a particular property or multiple properties in their IRA. Here are the steps to take. First, find a custodian willing to hold real estate investments in an IRA. Most banks and brokerage firms shy away from custody of real estate in IRAs because of valuation issues, as well as other administrative problems. Establish an IRA with your new custodian and transfer funds into it from an existing IRA.

The simplest scenario is one in which you purchase real estate in your IRA from an unrelated party for cash. You cannot use non-IRA funds for closing costs or any transaction-related expense. All costs must be paid from the IRA, and all income must stay within the IRA. Future property expenses must also be paid from IRA funds, so be sure you have a reserve put aside.

It can get a little more complicated if you plan to borrow or leverage. Loans are permitted on property in an IRA but subject to strict rules. The loan must be a non-recourse loan; the lender cannot hold or look to your personal assets as collateral if there is a default or deficiency on the property. For understandable reasons, lenders are often unwilling to make this type of loan.

There are also some complex rules that can get investors tripped up, relating to prohibited transactions and disqualified people.Prohibited transactions would include, among other things, selling a piece of property you already own to the IRA or buying real estate and then permitting a disqualified person to use it. You also may not purchase real estate for your IRA from a disqualified person, such as you or close family members.

Investing in real estate and other NTIs in an IRA has been worthwhile and lucrative at the right times for the right investors. Just be sure to do your due diligence.

Steven Weber, Registered investment advisor, and Gigi Harris, director of client communications, are members of the Bedminster Group, a fee-only advisor providing counsel to the Lowcountry since 1997.