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Including Real Estate in Your Pension Plan’s Investments


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Including Real Estate in Your Pension Plan’s Investments
Including Real Estate in Your Pension Plan’s Investments

Many people are aware of self-directed retirement plans for individuals (solo 401(k) plans and IRAs), which allow account owners to include many alternative assets in their plans—including real estate.

This brings up the question of whether a pension plan is permitted to acquire real estate as part of its investment strategy.

The short answer is “yes,” a pension plan may own real estate. However, plan sponsors and their advisors must be mindful of several key issues in order to comply with IRS regulations and avoid certain pitfalls. Here are important points to consider before including real estate investments within your pension plan.

1 – Ensure correct transaction structure

To include real estate in accordance with IRS guidelines, the pension plan trust must be the asset owner, with the trust ID number used as the appropriate tax ID. All income and expenses associated with the property must flow directly through the plan (property management, upkeep, taxes, rental income, etc.).

Note that a financial institution is not permitted to stake a claim against assets of a

pension plan. Therefore, if the plan obtains financing, the plan trust must hold the note and collateral for the loan should be provided from a source outside of the plan trust.

2 – Beware of prohibited transactions

Self-dealing is at the top of the list. Disqualified individuals are anyone working in your company (including you), business partners, financial advisors and others with fiduciary relationships, and your family members. These individuals may not use the property owned by the pension plan, nor personally gain in any way from it (such as performing work). Also, any personally owned real estate cannot be contributed to the pension plan.

3 – Taxation on gains

Funds that are withdrawn from the pension plan are taxed as ordinary income. We recommend you consult your tax advisor to review the tax implications of purchasing real estate within the pension plan, with consideration of your tax bracket and capital gains rates at the time of draw-down.

4 – UBIT

Unrelated business income tax (UBIT) is another tax consideration. Investors who use a self-directed IRA to invest in real estate that is financed with debt often discover their investments are subject to UBIT. Whether or not UBIT is triggered depends on two scenarios: a) the retirement plan invested in businesses that generate income, which is categorized as “trade or business income” from entities like a limited partnership or LLC; or b) real estate purchased within a tax-exempt retirement account is debt-financed.

One example of a UBIT trigger is if the pension purchases and develops raw land into residential properties to sell; that would be considered as running a business and the sales income would generate the tax liability.

Note that many rental scenarios are not subject to unrelated business income tax when the property is held in a retirement plan; however, there are certain exceptions that do not meet that test. Again, consult with a specialist to avoid unexpected tax liabilities.

5 – Accurate market value assessments

An accurate accounting of all plan assets must be conducted once a year to ensure that all participants’ interests are evaluated properly, including real property. All assets must be reported at market value. The plan sponsor may choose to hire an independent appraiser every year to satisfy this requirement or rely on other means to derive an accurate market value. However, if the IRS successfully challenges the accuracy of your reported property values, you could be subject to penalties and excise taxes.

6 – Annual asset audits

If you have plan participants other than you and your spouse, you must maintain fidelity bond coverage for at least as much as the combined value of all `your “non-qualifying assets” such as property, limited partnership interests, mortgages and other notes. Otherwise, you lose your “small plan” exemption from requiring an annual audit of your plan’s assets. An ERISA attorney can guide you on this matter.

7 – Plan termination issues

Complications arise when the pension plan terminates. The real estate within the plan has to be sold, or you (the business owner) may roll the plan account over to an IRA. The latter option requires the IRA be held by a financial institution (usually a self-directed retirement plan administrator/custodian) that will act as the trustee for an IRA that holds real estate.

Another option: keep the pension plan intact (a Defined Benefit plan must be rolled into a different kind of pension plan to do this). Further, since a business must sponsor a pension plan, you’ll need to sponsor a business for as long as you’re maintaining your plan.

8 – Is this practical with employees?

If your plan design enables each participant to direct how their account will be invested, all investment options available to you must also be made available to all participants. You must avoid discriminating against employees, which makes owning real estate in a pension plan impractical. 

Although real estate investing is popular among certain investors as a way to diversify their retirement portfolios, including real estate in a pension plan may not wise for many plan sponsors. At INTAC (part of FuturePlan by Ascensus), our retirement plan consultants are available to discuss your pension plan design and business goals to help you determine if this strategy will work well for you. Contact your INTAC pension consultant to learn more.