What happens when you find your perfect retirement home, but you are not quite ready to retire? Many real estate investors with IRAs have come up with the following solution: Purchase the future retirement home as an investment in their retirement accounts and park it there until they are ready to move in.
Let’s talk about the limitations first. When buying real estate in your retirement account, there are two basic rules: no personal use and no self-dealing. What does this mean? You are not allowed to use the property owned by your IRA. Period. You cannot live in it, stay overnight in it, vacation at the property…nothing. This rule extends to your spouse and your lineal relatives as well. Per IRS regulations, to prove that this property is an investment in your retirement account (just like you would invest in stocks or bonds), it must be investment only, no personal use. The no self-dealing rule means that you and your prohibited parties (your spouse and your lineal relatives) are not allowed to do any business dealings with your IRA. This means you cannot sell a property you already own to your IRA, buy a property from your IRA, do rehab work on the property, etc.
So, how can you eventually move into a property that your IRA owns and make it your home? The answer is an in-kind distribution. Any property that your IRA owns, including your future retirement home, can be pulled out of the IRA as a distribution. A distribution is not a sale where you must pay your IRA for the property. A distribution is just pulling the asset out of the IRA. Many people are familiar with pulling cash out of an IRA. You remove the cash via a distribution and add it to your earned income for the year. Depending on the type of IRA you took the money out of (traditional vs. Roth) you might or might not have to pay any taxes on that cash distribution.
When an IRA holder is looking to retire and make one of the properties in their IRA their retirement home, they are allowed to take an in-kind distribution (meaning you are pulling the property out, instead of selling it and pulling cash out). To do a distribution of property out of your IRA, you would have a deed prepared showing ownership is being transferred out of your IRA’s name and into your personal name. You would also need to have a certified appraisal submitted showing the current value of the property at the time of the distribution. The certified appraisal will determine the value of your distribution that will be reported to the IRS as income. Once that deed is recorded showing you are the owner of the property, you may treat the property as your vacation home, personal residence, etc.
Always seek professional advice. You should consult your CPA or tax advisor prior to purchasing your future retirement home in your IRA and also before taking a distribution of that property, as doing so could result in a large tax bill. Your tax advisor will sometimes recommend you take a distribution in a year when your income drops (such as retirement) or a year in which you have some personal losses that will help cancel out the tax bill. Some individuals find it financially advantageous to take a small percentage of the property out over several years to minimize the tax bill. You can distribute as much or as little of the property to yourself each year. A partial distribution would result in your IRA owning a percentage of the property and you owning the remaining percentage. All bills and all income would be split between you and your IRA according to the percentage of ownership. Once the IRA no longer owns any portion of the future retirement home, the IRA holder can move into the property and retire in happiness. One last item to consider regards new improvements that may be planned for the property, such as new construction or renovations. If the property is owned by the IRA, the new construction or improvements must be paid for using cash in the IRA. Once the property is owned by the IRA holder personally, the IRA holder can use personal cash for any bills or improvements to create the perfect retirement home.