Owning a property with your self-directed IRA is a great investment option but it also comes with a certain amount of responsibility for you as the account owner. Although you are not allowed to act in the capacity of property manager, or physically work on or live in the property, you must manage the account that owns the property. Managing the IRA includes selecting a property manager, hiring contractors when and if needed and authorizing payments for expenses such as repair work, property taxes and insurance. The IRA owner must also make sure that the cash balance of the account meets the minimum required by the Custodian. Preferred Trust Company requires that five (5) percent of the purchase price of the property plus $500.00 must always be kept in cash in the IRA. Why does Preferred Trust require a holdback amount?
It is important to avoid overextending the IRA into an investment where the IRA may end up being unable to cover unexpected expenses. The IRA owner cannot personally pay the expenses owed by the IRA as that would constitute a prohibited transaction by a disqualified person. Industry experts recommend that the IRA maintain ten (10) percent of the purchase price of the property in liquidity to cover unexpected expenses.
Examples of some of these expenses include loss of rental income, damage from natural disasters and other accidents and increased insurance premiums and property taxes.
What are your options if you do overextend the IRA and the liquidity of the account becomes less than the required amount? The IRA owner may be eligible to make an annual contribution to the account to cover the shortfall. If the IRA owner has more than one retirement account, they may also be eligible to transfer or rollover an amount from that account to the IRA that owns the property. In extreme circumstances the IRA owner may rely on Department of Labor Prohibited Transaction Exemption 80- 26, which allows the IRA owner to loan money to his or her IRA so that the IRA may pay the obligations that it owes. This type of loan – from the IRA owner to the IRA is only permissible if certain criteria and conditions are present. It is important for the IRA owner to discuss this option with the IRA Custodian as well as a CPA or qualified tax specialist.
This type of loan is not permissible to fund new obligations or to make new investments but can be used as a last resort.
Finally, if the IRA does become overextended and is unable to pay the expenses owed and the options listed above are not viable, Preferred Trust Company will elect to resign as Custodian of the IRA owned property. In this scenario ownership of the property will be transferred to the IRA owner personally which is a taxable event.
It is important to be aware of this information to avoid causing the IRA to become overextended. Preferred Trust Company provides clients with online access to their accounts, 24-hours a day, seven days a week. This type of access allows clients the ability to check the available cash balance of the account, view transaction history, verify rental income received and confirm expenses paid.
Representatives from Preferred Trust Company are available Monday through Friday from 8 am until 5 pm to discuss the minimum cash requirements with you and answer any questions you may have.