Last week’s blog discussed setting up a self-directed plan that allows real estate in your IRA. As promised, this week’s topic covers how to properly manage those assets. There are specific rules you must adhere to in order to comply with IRS regulations so your self-directed IRA works for you instead of against you.

Now that you have set up your self-directed IRA, have it properly funded, and are ready to begin looking for property there are several things to keep in mind. While self-directed retirement plans allow many different alternative investment options, there are strict guidelines relevant to prohibited transactions and disqualified persons you must be aware of. Failure to comply could cause your IRA to suffer heavy penalties or even disqualification.

When exploring real estate options, know that your IRA is not allowed to purchase property from you or from another disqualified person. Your IRA is also not allowed to sell property to you or a disqualified person. Disqualified persons include:

The IRA holder and his or her spouse

The IRA holder’s lineal descendants (children, grandparents, etc.) and their spouses

The IRA holders lineal ascendants (parents, grandparents, etc.)

Investment advisers, managers and fiduciaries

Any corporation, partnership, trust, or estate in which disqualified persons have a 50 percent or greater interest

Anyone providing services to the IRA

Another important thing you need to understand is all property your IRA acquires is owned by your IRA and not by you. Any earnings gained, whether through resale or rental income, flow directly into the account. Expenses relative to the property must be paid directly from the IRA. When purchasing real estate in your self-directed IRA, it’s critical to plan for anticipated expenses in advance, so your IRA is prepared to cover them. If you have partnered on a purchase with other parties, your IRA only pays for its percentage of repairs and also must receive only its share of income.

Additionally, you are unable to use the property for personal purposes. For example, if you own a vacation rental you or other disqualified persons may not vacation there. The real estate was purchased to build wealth for your retirement. Using the property for personal purposes before you hit retirement age would be considered a current benefit and your IRA will be penalized, if not disqualified.

You are personally not allowed to perform repairs or maintenance on real estate in your IRA. Doing so constitutes “sweat-equity” and is considered a contribution to your account. The IRS only permits contributions to an IRA to be made in cash—and sweat equity cannot be measured in value. Repairs and maintenance must be performed by a third party—who is not a disqualified person—and paid at current market rates.

On the flip side, you do not have to hire a third party to manage the property in your IRA. The IRA owner is able to manage the property as long as you don’t perform sweat equity or pay for expenses out of your own pocket. Again, all income and expenses flow directly into and out of your self-directed IRA. Rent checks and other income must be written to the IRA and deposited directly into the IRA account. Income or expenses are not allowed to flow through the IRA owner for any reason.

Hopefully it goes without saying that it is crucial you perform due diligence when looking for real estate to acquire in your IRA. You want to find a decent property in a location suited for the purpose you desire. If you want a quick rehab-and-flip, the goal would be that the cost of the property plus the money it costs your IRA to renovate is low enough for your IRA to make a profit at resale. Location is key whether conducting a rehab or acquiring rental property—you want to be as sure as you can be there is a market for resale or good potential for acquiring tenants for rentals.

If you have any questions regarding real estate in your IRA, please contact Monte Smith at Advanta IRA Administration by calling (800) 416-8736 or emailing MSmith@AdvantaIRAGroup.com.