What Does the IRS Think of Investing in Real Estate?!

Has anyone ever asked their financial professional (e.g., banker, accountant, broker, drinking buddy….just kidding on the last one) what types of assets their IRAs and 401Ks can invest in OTHER than stocks, bonds and mutual funds? Ever? I know you must care or are you one of the millions that believes that you can only invest in Wall Street products?

The simple truth is that most all of us have been brainwashed into believing that our only option is to invest in the world of stocks, bonds and mutual funds (i.e., traditional investments). Our brokers have convinced us that “diversification” is within traditional assets, not outside of it. I mean seriously….is this true diversification?! Others believe that only the very rich can set up plans to invest this way.

But, as many individuals are upset about their portfolio balances and exploring options for investing their funds, their “professional” typically continues to steer them in the market. And, sometimes, they make a pretty good “pitch” for the reasons why one should keep their funds in the market. But, let’s use common sense….is it potentially better to diversify in up to as many as 23 asset classes or 3?

Now, this post is not to criticize financial professionals…..many who are ignorant to the fact that retirement funds can be invested in sooo much more. Their financial stewardship “sermon” hinges more on how THEY were trained, educated AND paid. And, how are they paid? You’re right….based on what you buy from them! Think of it this way….how many people do you know who would actively encourage you to invest in something that they were not paid for?! (cheat sheet here…..in 2005 93% of ALL financial transactions on Wall Street were to BUY, not sell!)

So, for those of you that HAVE asked your financial professional if you can invest your retirement funds in assets such as real estate (and a plethora of other assets), you will typically hear some of the following:

Actual Financial Professional Statement – “You can’t do that (invest in real estate). There is no way the IRS will let you do that?”

Well, what does the IRS say? This is a statement from their website:

“…..because of administrative burdens, many IRA trustees do not allow IRA owners to invest IRA funds in real estate. IRA law does not prohibit investing in real estate but trustees are not required to offer real estate as an option.”

By the way folks, while the quote references IRAs, the same standards as to permissibility apply to 401K and other retirement plans as well. Also, with the above statement, the “trustee” is going to be your bank, trust, brokerage firm who is the one choosing what they wish to offer you. It is not the IRS that is saying that you cannot invest in assets such as real estate.

Actual Financial Professional Statement – “I heard somewhere that you can MAYBE do that (invest in real estate), but it is REALLY complicated. I also heard that you have to create a Trust with an attorney and, of course, that will be really expensive.”

Well, what does the IRS say? This is from the IRS website which defines what an IRA actually is:

“An individual retirement account is a trust or custodial account set up in the United States for the exclusive benefit of you or your beneficiaries. The account is created by a written document. The document must show that the account meets all of the following requirements.
• The trustee or custodian must be a bank, a federally insured credit union, a savings and loan association, or an entity approved by the IRS to act as trustee or custodian.
• The trustee or custodian generally cannot accept contributions of more than the deductible amount for the year. However, rollover contributions and employer contributions to a simplified employee pension (SEP) can be more than this amount.
• Contributions, except for rollover contributions, must be in cash. See Rollovers , later.
• You must have a nonforfeitable right to the amount at all times.
• Money in your account cannot be used to buy a life insurance policy.
• Assets in your account cannot be combined with other property, except in a common trust fund or common investment fund.
• You must start receiving distributions by April 1 of the year following the year in which you reach age 70½.”

Folks, where does it state that you cannot invest in real estate? You’re right, it doesn’t.

So, as I tell my clients, my job is to educate. An IRA or 401K can invest in a plethora of other assets other than stocks, bonds and mutual funds. Are we experiencing unprecedented times where investing in real estate may be ideal. Of course. Should you invest in real estate? Maybe yes, maybe no. The fact is that it is YOUR decision, not your broker’s. Would we all agree that having more options and choices with our investment funds is advantageous to us….ABSOLUTELY!

Take control of your finances. Don’t put your head in the sand and HOPE! Just like putting in some good sweat equity to achieve good physical health, you must put in some good educational equity to achieve good financial health. Don’t be afraid….cuz as is oft said but is so true…..