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Spice Up That IRA

Terry Savage

What's in your individual retirement account? It's a safe bet that you've invested in mutual funds, stocks, bonds, and maybe even in a bank certificate of deposit or money market fund. But if you've built up substantial sums in your IRA -- either from wise investing, or from rolling over 401(k) plans from previous employers -- maybe it's time to graduate to some more sophisticated investments.

Federal laws restrict investments in life insurance and collectibles inside an IRA. You can buy gold and palladium bars, but you can't invest in collectible coins, with the exception of certain gold and silver Eagle U.S. coins minted by the federal government. You can't buy artwork, gems, carpets, alcoholic beverages or stamps inside your IRA.

But you are allowed to buy investment real estate, ranging from condos to partnerships to farms, or shares in non-public companies inside an IRA. Few people do this, however, simply because of the perceived difficulty of finding an independent custodian to hold the property and value it each year.

That's the opportunity for independent trust companies to step in and provide such a service. The Entrust Group, one of the largest, has built a huge business since its founding in 1981, and now serves as administrator for more than $2.5 billion in "unusual" IRA assets. CEO and founder Hugh Bromma says the process is easier than most people imagine. But he warns that you must follow strict rules if you want to make real estate investments inside an IRA.

Alternative Investments in an IRA

The most important rule is that your IRA investment cannot involve "self-dealing." That means you can't purchase a condo and "rent" it to your child who is a college student. In fact, if any member of your family is involved in the real estate transaction, either as a seller, buyer or user of the property, it is sure to raise a red flag with the IRS.

If you're concerned about the validity of an investment for your IRA, you can contact the Labor Department for a ruling to determine whether it would be a "prohibited transaction."

Dealing with real estate partnership investments or a cash real estate purchase is relatively easy. The independent administrator handles all the paperwork and deals with the seller or developer, attorneys, and title company. Before the deal closes, the client must read and approve all documents. Then the forms are signed by the custodian/trustee to make the purchase on behalf of the IRA. As custodian, the trust company is prohibited from making any money on the real estate deal itself.

Tricks of the Trade

If there's a mortgage involved in the purchase, it creates some tricky details. Since the IRA is the owner, the loans cannot have recourse to the individual who owns the IRA. And, of course, the IRA must be funded with enough cash to make the monthly mortgage payments, and taxes and insurance, on the property titled in the IRA. That's why most property purchased in an IRA is income-producing -- although the IRA must have enough liquidity to pay monthly costs in case the property is not rented for a period of time.

There's another liquidity issue. Once the IRA owner reaches age 70-1/2, he or she must start making withdrawals. That's no problem if there is cash or liquid assets in another IRA, since the required minimum withdrawal can be made from any one of these accounts. Still, the trustee must be able to value the property so the minimum can be calculated. In the absence of other liquid assets, all or a portion of the real estate in this IRA might have to be sold, perhaps in a difficult market.

Finally, if you're going to invest in real estate inside your IRA, do it only with a small portion of your funds, and in a separate account, so all your assets won't be penalized if the IRS disallows your real estate investment.

The Cost of Independence

There are costs to setting up this type of IRA. Entrust charges a one-time $50 fee to open the account, plus a one-time charge of $95 for the purchase of property. There may also be fees for wire transfers of money to settle a real estate deal. Then there is an annual fee of $250 a year for each asset, no matter what its value is. You can contact Entrust at www.TheEntrustGroup.com or (888-340-8977) to find your nearest local office.

Competitors have similar services and fees. They include: FiServ Trust Company (800-962-4238), Sterling Trust (800-955-3434) and Equity Trust (888-382-4727).

Buying alternative investments inside your IRA may be too complex for most people. But if you're willing to do your homework and follow the rules on real estate investing in your IRA, the trust companies are ready to help. And that's The Savage Truth.