EvaRosenberg

Imagine you could invest $100,000 in a piece of real estate today and sell it 20 years from now for nearly $400,000 without paying a dime in taxes. If you could buy that real estate with funds held in a Roth IRA, that could happen. And if the proceeds were drawn-out judiciously, you could even get the same result with funds held in a regular IRA.

Can you really do this?

To get some solid answers, TaxMama brainstormed with Mark Luscombe, a CPA and attorney, who is the principal tax analyst for CCH, a Wolters Kluwer business.

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Yes, you can buy real estate in your IRA, Roth IRA, or other retirement account. But it isn’t easy, Luscombe warns. In fact, it is quite complicated — and you’ll face many issues that might invalidate your IRA-based investment. Here are some of the obstacles you must overcome:

You must establish a self-directed IRA (Roth or regular), which may mean setting up a limited liability company or other entity to hold the assets.

Luscombe explains that you must find a plan administrator willing to allow you to use your IRA funds to buy real estate. The administrator will generally follow strict due-diligence rules. Once you find the property you want, you’ll need to convince the administrator that this property is a good investment for the IRA to own.

Be careful about the administrator you select. Just as some commission-based financial planners have a vested interest in selling you their pet investment, so do certain administrators. You want one that is not promoting properties but is simply administering accounts.

Next, roll over your retirement funds to this new retirement account. Two things you need to know about this rollover:

1. The more money you have, the better off this self-directed program will be. We’re talking about at least $100,000 or more. Unless, of course, you live in an area where you can buy rental property for $30,000 or $40,000. Find a property that will both appreciate in value and generate enough cash flow to cover all costs without your needing cash infusions annually.

2. If you don’t have enough money to buy a self-supporting property, you may need to set up the new retirement account so that you can contribute more than the $5,000 or so per year that an IRA would allow. How? Folks in business have some options: SEP-IRAs or solo-401(k) accounts. Those accounts will allow you to contribute up to about $51,000 per year, depending on your profits. Remember, these days, solo-401(k)s have Roth components, too. Consider taking advantage of them.

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Regarding Roth vs. regular retirement accounts, which way should you go? When moving funds from a tax-deferred retirement account to any kind of Roth account, all the taxes must be paid for the year of the conversion. Take into account how much money you’re going to lose right up front without any special programs in place allowing you to spread your tax payments over two or four years. Depending on your tax bracket and the amount of the conversion, expect to pay 33% to 35% in federal taxes, plus your state taxes. This may be a waste of money.

On the other hand, if you’re setting this self-employed retirement account up in the first place, you can establish it as a Roth-type account. It may take you a few years to build up enough funds to buy a property, but buying real estate in a Roth account means all the assets in the account will be totally tax-free when you retire.

Of course, if you know that you, your spouse, or your dependent will be facing high medical expenses upon retirement, a regular IRA is just fine. You’ll be able to offset draws from the IRA with your medical expenses. It takes some planning.

What kind of property can you buy in your retirement account?