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Rolling an IRA into rental property

Dear Money Matters,
I have been investing my IRA savings in mutual funds until now. I've given up on waiting for stocks to supply any growth. I was told recently that I can roll over my IRA into property, specifically rental property. Can I do this and, if so, how?
Travis

Dear Travis,
I sympathize. The recent sluggish performance of the stock market as a whole has been frustrating. I'm certain you're not the only investor on the block looking for alternatives.

It is possible to roll over your IRA into rental property, although the mechanics can be somewhat convoluted. First, as I understand it, you simply can't roll over your IRA from mutual funds into real estate as effortlessly as you would roll it over from one fund to another. The most complicated and troublesome element is finding a suitable custodian. This would be an entity, such as a bank or a trust company. You would have to open a self-directed IRA with them, and they, in turn, must be willing to accept the deed to the property as an asset in the account.

Needless to say, it may be a bit difficult to track down a custodian who's comfortable accepting property as an IRA asset. Out of curiosity, I called three banks where I live and none said they would be willing to do so. Of course, it may be different where you are, but it may be the case that many banks and other similar institutions -- conservative and close to the vest as they are -- may be a bit gun shy about straying too far from the IRA norm.

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You should also know that rental property has its share of pitfalls, just like any other sort of investment. For one thing, there's no guarantee that property values where you live are going to appreciate. Similarly, there's no certainty that you're always going to find tenants, let alone tenants who -- gasp! -- pay the rent in full and on time. That can leave you paying the mortgage and upkeep out of your own pocket. Lastly, give careful thought about how involved you might want to be as a landlord. If you're going to handle things yourself, that may mean being rousted out of bed at 2 a.m. to charge over with a plumber's wrench in hand. By contrast, if you hand off your rental to a management company, the cost will cut into your return.

If the notion of real estate appeals, you may want to consider putting at least a portion of your IRA into a Real Estate Investment Trust. These are bought and sold like mutual funds and invest in real estate. There are three types -- Equity REITs own property directly; Mortgage REITs deal in mortgages; and a third hybrid does both.

Unlike many stocks which don't pay any sort of dividends, all REITs pay dividends. And the rate is, historically speaking, rather good. For instance, last year REITs paid an average of 8 percent in dividends. Additionally, since the REIT would be in your IRA, you won't owe any taxes on any of the income until you start withdrawing the money. Finally, although REITs can move up and down with the markets as a whole, they inherently offer diversification across a number of properties. If, by contrast, you put your money into just one piece of real estate, your fortunes are tied solely to that one property.

-- Posted: July 8, 2002

More Money Matters columns
See Also
Checking out your investment plan
Don't put investing eggs in one basket
Financial advice glossary
More Money Matters stories

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