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Experts Who Don't Understand Real Estate IRAs

Recently one of our clients alerted us to a syndicated columnist writing about- You guessed it: Real Estate in IRAs. She went so far to state that anyone who says it's ok is committing fraud!

Here is the essence of the quoted communication:
 
I received a copy of your article "Retirement accounts can't be used for realty", published in X., from a client and attendee of a client workshop.
 
IRAs and Qualified Plans, also known as Keoghs (which include 401(k) plans, have been able to invest in real property for over 25 years.
 
The quotes from (the expert senior tax analyst for CCH Inc., one of the largest publishers of tax information for businesses and consumers) Mr. Sulzer may not be referring to this fact, giving him the benefit of the doubt. Nowhere in the Internal Revenue Code is there any statement that IRAs or Keoghs are prohibited, or not permitted to invest in real estate. (In fact the IRS code specifically states that collectibles are not permitted in IRAs, and specifically what prohibited transactions are. The Code specifically states that collectibles are not permitted in IRAs. Real Estate, notes etc. are not listed as prohibited investments and they are not collectibles.)
 
However, real property is not prohibited. This is where I think Mr. Sulzer may either be misinterpreting the code, or attempting to make the point that an IRA (or Keogh) may not purchase a property or asset from the account holder of the IRA or Keogh. This latter point of view is supported by the inference made in the quote later in the article:
 
The tax court views these rules strictly, Sulzer says. 'They specifically preclude using IRA assets to purchase a residence while the assets are in the account.' The residence that Mr. Sulzer must be referring to is a personal residence, or one in which one intends to reside, while owned by the IRA. Later Mr. Sulzer's quotes regarding IRS publication 560, are correct, but again the idea is that a transaction would have to be between the beneficial owner or the plan and his or her owned property. (He also forgot about IRS Publication 590, which addresses IRAs specifically.)
 
Mr. Sulzer's comment about administrators of 401(k) plans permitting investments in something that wasn't sound, begs the question: what is sound?
 
Many profit sharing plans (which are the vehicles used to permit employees to defer income under 401(k)) are self directed as far as investments are concerned. This means that individuals are permitted to make their own decisions regarding the investments they choose. If one were to just be able to choose only stocks bonds or mutual funds, and the employer provided, say stock funds which have only one third of their value from two years ago, or a bond fund which is flat, and a money market, as opposed to real property which has gained in value over the last three years, is the employer at risk for curtailing investment opportunities? Mr. Sulzer's comment regarding fiduciary relationships are essential for qualified plans, but do not operate for self directed IRAs, owner only profit sharing, money purchase pension, or 401(k) plans. Even in plans where the common law employees are permitted to self direct their plan assets, one must be careful to ensure that one does not violate prohibited transaction rules.
 
The paragraph regarding the only permitted investments including stocks, bonds, mutual funds and REITs is incorrect.. The only things which are not permitted are those prohibited in Section 4975 of the IRS code, and for IRAs, collectibles. Please note that the IRS does not have an approved or non-approved list of investments. You may find this reference from the IRS on our website.
 
Next, the purchase of retirement homes in IRAs and Qualified plans: the beneficial owner of such an account may direct his or her plan to purchase a home in an IRA for investment purposes. This means that a disqualified person (say the beneficial owner, his or her ascendants or descendants) may not have use or live in the home, as this would violate the prohibited transaction rules. However, when the individual is eligible to receive a distribution from the IRA or plan, the home may be distributed to the beneficial owner, at which time tax must be paid (unless it is in a Roth IRA) on the value of the home.
 
The self directed plans, including IRAs and Keoghs, permit complete diversification in any assets permitted by law, which includes real property, notes and most anything else. This includes leveraged real estate, the leveraged portion being subject to unrelated business income tax.
 
There are about 15 major companies and hundreds of banks trust departments which administer IRAs and Keoghs where clients have held Real Estate, Notes, LPs, LLCs and many other diverse investments. All of these are regulated by an agency of the federal government. All of these companies and banks know the IRS code, and know what it says. The IRS code along with private letter rulings and prohibited transactions, and publications 560, 590, 575 and more deal with this subject in some form.
 
I am concerned that this article may cause confusion among the population at large. I know that you are aware that when anyone reads anything in the news, may assume that what they read is absolutely true. It then takes us, the people who know, enormous effort to deal with the incorrect and misleading information, while at the same time attempting to explain what is correct and why the inferences where made.
 
The response was:
 
"I have heard from a lot of people who seem fairly confident that this practice is not only legal, but sanctioned from the IRS. On the other side, are the accountants, tax attorneys and the fellow from CCH who do not believe this is legal."
 
The author went on to say that she may do additional research on the subject and do a follow up article. We hope she does, and we also hope that she does research on the subject. We also think that Mr. Sulzer, the only source quoted in the article has time to do research also. Who knows, maybe he will appreciate the opportunity to diversify his IRA or qualified plan in directions other than just stocks, bonds, mutual funds, CDs and REITs.
 

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