DanMoisand

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Real estate can be a fine investment but if you want to buy it inside your IRA, there are many complications to consider. This week’s featured question delves into some of these issues as a reader wonders if he can buy some raw land.

Q. Can an IRA account balance be used to buy real estate land? For example, you take your $100,000 IRA and buy a real estate property (land only) for $100,000. Then when you are required to start your IRA’s Required Minimum Distribution payments, are you forced to sell the land so the RMDs can be paid to you? Thank You — Bob

A. You are permitted to buy some types of real estate with IRA money but you are wise to be careful. If that is your only IRA or a large chunk of your nest egg, I would not be enthusiastic about buying the land in the IRA. If there is an error, the entire IRA can be deemed taxable.

The property cannot be mortgaged. It needs to be strictly an investment property so no personal use and don’t think you can build a second home for your family on it. In fact, neither you nor anyone in your family can transact with the property. An outside party will need to be hired to manage or maintain it.

Those maintenance expenses, taxes, insurance and other expenses must be paid out of the IRA so cash will need to be available in the IRA. Run out of IRA cash and you have a problem so having a good handle on how long you would hold the property is important.

You are correct that meeting your Required Minimum Distribution can be challenging. If you have other IRAs, you could take the RMD from those accounts but you still have a valuation issue. IRAs must have a custodian to track and report value and activity to the IRS. The custodian must report a value to the IRS as of each Dec. 31 and valuing property can be expensive.

Most custodians that will hold a property will provide you with information about the ins and outs but if you read their materials closely, it is likely you will see the ultimate responsibility for complying with all the rules (prohibited transactions, self-dealing, and others) rests on you. Most people opt to buy property with non-IRA funds or indirectly through other means such as real estate investment trusts. If you wish to invest directly in property with your IRA, retain your own counsel.

Q. Mr. Moisand, My wife and I are in our mid 30’s with two kids and later this year will have both cars paid off. This will provide us with extra $1,000 in income. We are 5 years into a 30-year 4.5% fixed mortgage and of the $1,000, half would go towards IRA or extra mortgage payment. My plan for other half is to save for future new cars (no more car payments) or emergency fund if needed. Should I put extra cash toward IRA now or pay off mortgage? Thank you for any response you may provide. — Chris

A. Chris, this is one of those financial issues that is far more than a financial issue. From a purely mathematical standpoint, if your after-tax earnings exceed the after-tax cost of the debt, your net worth is better off by keeping the debt. So, some of the factors in figuring that out include where you invest the IRA, whether the IRA is a Roth or traditional, whether you can deduct the contributions to a traditional, how much of the 4.5% mortgage interest is deductible, rate of return on the IRA, and at what rate your home appreciates. The more conservative you are from an investment standpoint, the more attractive paying down the mortgage will become.

That’s just the math. The two non-mathematical issues that arise most often are peace of mind and liquidity. The peace of mind that comes from having no mortgage is hard to value but is quite valuable to many and more than enough to ignore favorable math.

For liquidity, you have to consider that you can’t just sell one of the bathrooms so if you have paid off the mortgage but do not have accessible sources of cash, when you need money, you either sell the house or more likely put some debt on the home. Taking money from retirement accounts has tax consequences that for person’s under age 59 ½ can be harsh. So, that emergency fund idea is a good one either way.

Q. I will be 66 in May of 2014. My wife will be 65 in August of 2015. I plan to file for my benefits in May of 2014 and suspend so my monthly benefits continue to grow. When my wife files in August 2015, (at age 65) I plan to file for spousal benefits (50% of her benefit) against her benefit while she collects against her own benefits. I would then begin to collect my benefits when I turn 70. Since she will continue to work until she is 65, and we will not need benefits until August 2015, is this the best strategy? Thank you — J.M.

A. Hi J.M. the rules don’t allow what you describe. In order for you to get a spousal benefit off of her record and still earn delayed credits on your retirement benefit, you would need to file a restricted application. You can only do this after she files for her benefit and if you have not filed for your own by that time.

Q. Hi, In one of your Q&A sessions on Social Security taxation. you mentioned taxable income or adjusted gross income from the context of combining Social Security income and other types of income such as tax-free income. Does tax-free income include qualified Roth IRA withdrawal in addition to tax-exempt muni bonds?

Reader Questions

Reader questions on all things retirement answered Mondays and Fridays. If you have a question for Dan, please email him at: RetireQA@marketwatch.com

Dan Moisand’s comments are for informational purposes only and are not a substitute for personalized advice. Consult your advisor about what is best for you.