Guest Opinion: Should you invest IRA funds in real estate?

The views expressed in Guest Opinions represent only those of the author and are in no way endorsed by Richmond BizSense or any BizSense staff member.

Q: I am looking for a way to get into the distressed real estate market. What do you know about using the money in my IRA or 401(k) money to invest in real estate?

Sincerely,
Cash Poor and IRA Rich

Dear Cash Poor,

You have good financial instincts. Real estate could be a great investment right now, and we are currently increasing exposure to this sector. But the risks and accounting red tape when making direct investments using IRA or 401(k) money should be avoided.

Cashing out a traditional individual retirement account (IRA) or 401(k) will trigger a taxable distribution and usually an additional 10 percent early-withdrawal penalty for people younger than 59½. I don’t recommend this approach because the penalty is high and the investment results unpredictable. One recent belief that I hope has been forever scorched from the American consciousness by the recent recession is the idea that real estate investments always increase in value.

Another ill-advised option would be to transfer your IRA to a self-directed custodian that allows for real estate purchases. These transactions have been gaining popularity, but I believe most investors should avoid these complex techniques. You will likely lose the power of leverage because few banks lend money to an IRA. Additionally, you can’t deduct property taxes and you can’t use depreciation. When an IRA holds the property, an individual is not allowed to cover an expense – such as buying paint or new granite countertops – out of personal funds or it will likely be deemed a prohibited transaction in the eyes of the IRS and could cause your entire IRA to be taxed.

Many 401(k) plans allow you to take a loan of 50 percent of the vested account balance up to $50,000. Borrowing from your 401(k) is penalty free, unless you don’t pay the money back. Then the usual early withdrawal penalties apply. You are charged interest on the loan because your 401(k) is the bank, and the interest gets added to your account. Most plans also require you to repay the loan within five years and definitely before you change employers. I would suggest not tapping your 401(k) plan.

Don’t get me wrong. I believe this is a good time to invest a portion of your portfolio in real estate. In fact, after being out of the real estate markets for several years, our firm is recommending a 4 percent allocation in diversified portfolios. If you don’t have the cash or financing available to purchase directly, consider investing your IRA or 401(k) money in a real estate investment trust (REIT). These investment pools are typically publicly traded and run by real estate investment professionals. You can invest directly in specific REITs or indirectly through diversified mutual funds and exchange-traded funds (ETFs).

If you are looking for an easy recommendation for an investment vehicle, try the Vanguard REIT ETF (symbol is VNQ). The expense ratio is 0.15 percent, and the effective yield is 3.5 percent. This is by far the simplest and most cost effective way to take advantage of this trend. If you do invest in real estate, remember it is a long-term investment, and like all such investments, you will have to give it time.

The views expressed in Guest Opinions represent only those of the author and are in no way endorsed by Richmond BizSense or any BizSense staff member.

Q: I am looking for a way to get into the distressed real estate market. What do you know about using the money in my IRA or 401(k) money to invest in real estate?

Sincerely,
Cash Poor and IRA Rich

Dear Cash Poor,

You have good financial instincts. Real estate could be a great investment right now, and we are currently increasing exposure to this sector. But the risks and accounting red tape when making direct investments using IRA or 401(k) money should be avoided.

Cashing out a traditional individual retirement account (IRA) or 401(k) will trigger a taxable distribution and usually an additional 10 percent early-withdrawal penalty for people younger than 59½. I don’t recommend this approach because the penalty is high and the investment results unpredictable. One recent belief that I hope has been forever scorched from the American consciousness by the recent recession is the idea that real estate investments always increase in value.

Another ill-advised option would be to transfer your IRA to a self-directed custodian that allows for real estate purchases. These transactions have been gaining popularity, but I believe most investors should avoid these complex techniques. You will likely lose the power of leverage because few banks lend money to an IRA. Additionally, you can’t deduct property taxes and you can’t use depreciation. When an IRA holds the property, an individual is not allowed to cover an expense – such as buying paint or new granite countertops – out of personal funds or it will likely be deemed a prohibited transaction in the eyes of the IRS and could cause your entire IRA to be taxed.

Many 401(k) plans allow you to take a loan of 50 percent of the vested account balance up to $50,000. Borrowing from your 401(k) is penalty free, unless you don’t pay the money back. Then the usual early withdrawal penalties apply. You are charged interest on the loan because your 401(k) is the bank, and the interest gets added to your account. Most plans also require you to repay the loan within five years and definitely before you change employers. I would suggest not tapping your 401(k) plan.

Don’t get me wrong. I believe this is a good time to invest a portion of your portfolio in real estate. In fact, after being out of the real estate markets for several years, our firm is recommending a 4 percent allocation in diversified portfolios. If you don’t have the cash or financing available to purchase directly, consider investing your IRA or 401(k) money in a real estate investment trust (REIT). These investment pools are typically publicly traded and run by real estate investment professionals. You can invest directly in specific REITs or indirectly through diversified mutual funds and exchange-traded funds (ETFs).

If you are looking for an easy recommendation for an investment vehicle, try the Vanguard REIT ETF (symbol is VNQ). The expense ratio is 0.15 percent, and the effective yield is 3.5 percent. This is by far the simplest and most cost effective way to take advantage of this trend. If you do invest in real estate, remember it is a long-term investment, and like all such investments, you will have to give it time.

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joseph LaPaglia
joseph LaPaglia
12 years ago

Just discovered this site. My comments are from investors point of view, ………….. I have skin in the game. Now is absolutely the best time to invest in real estate ( unless the US goes totally Socialist communist Marxist) The Big question is what type of investor are you and what are you goals /needs, etc. You must understand things like; Good debt/bad debt, leverage, tax strategies and business structures, IRR ( internal rate of return), OPM (other peoples money), control is necessary /ownership is not, risk/reward ratio, and get this info from an actual investors point of view Self… Read more »

Jesse Lennon
Jesse Lennon
12 years ago

Moving your money or at least a portion of it to a truly self-directed IRA (Retirement Account) Custodian is a GREAT idea! There are many fine custodians out there such as Equity Trust (formerly Mid-Ohio), Pensco and Entrust. You can invest in many various types of investments directly through your IRA such as stock, bonds, use it to provide venture capital for a new business, lend to an existing business, etc. As for Real Estate investments (my personal favorite investment vehicle for over 26 years); you can use your IRA to buy real estate to resell or rent, partner with… Read more »

Matthew Illian
Matthew Illian
12 years ago

Dear Jesse, these Q&As are primarily directed at investors who desire to make smart money decisions without the hassle of actively managing complex investments. These are business owners who are already focused in their own area of genius but know that it is wise not to have all of their resources tied up in their business. Or super savers who want a tax efficient and low cost way to fund their nest eggs. In my view, the experience of the average investor is akin to being told to swim to shore after being placed in the middle of the ocean… Read more »

Linda Heath
Linda Heath
12 years ago

What a fascinating article. I’d like to add several points to the discussion. 1. I think the question “should I invest IRA in R/E” is the wrong question. A more useful question would be: “Under what circumstances is R/E a good IRA investment?” 2. With the revised question you can build a matrix to organize all the info presented above. This should lead to a more informed decision on an individual basis. 3. Note that Mr. Illian’s firm is recommending only a 4% investment in “diversified portfolios”…I assume that means real estate. One would have to have $100,000 in the… Read more »