Your claim could be denied
If you have a rental property insured under a homeowner’s policy, you run the risk of having claims denied because you misrepresented the property in applying for insurance.
For example, say a tenant had a space heater that catches on fire and burns the house down. If you have homeowner’s insurance and your insurance carrier figures out the house was not owner-occupied but actually tenant-occupied, the carrier has the right to deny that claim which could result in you not having insurance to cover that damage.
At best, you could spend thousands of dollars in litigation fees. At worst, you could lose the entire value of the home in the fire.
[Related: Common Rental Property Risks and How to Minimize Them]
Your insurance provider won’t come to your defense
The wrong kind of insurance could hurt you from a liability perspective as well.
For example, say a tenant’s dog attacks the mailman. Your insurance carrier will not provide a defense for you if a tenant was living in the house instead of you.
Covering the cost of missed rent payments
Typically, if your rental property is significantly damaged and needs extensive repairs, the tenant will move out and you lose the ability to generate income on that house for several months. Meanwhile, you’re still paying taxes, your mortgage, and other property expenses without collecting any rental income. Given the time it takes to repair a significantly damaged home, you could lose over $20,000 in rental income for your self-directed IRA.
Conversely, a homeowner’s insurance policy typically pays for temporary residence for you and your family while repairs are taking place in your own home. However, if the claim is made on a property that’s not your residence, the policy will not provide a temporary residence for someone else, nor are they going to reimburse you for your loss of rent during that time.
If you properly purchase a rental dwelling policy, you will be reimbursed for any lost rent during the time of repairs under business interruption insurance.
With a homeowner’s policy, you’re not going to have loss of rent or business interruption coverage.
One more consideration: rental properties in an IRA could inadvertently create a taxable event
Now that you’re aware of the coverage needed for a rental property, there’s one more consideration: If your rental property is held in an IRA, you need to make sure the insurer understands the unique requirements involved.
All premium payments need to come from the IRA and any claim payments need to be made to the IRA. If you personally receive a check from an insurance company that should have been paid to the IRA, the IRS could consider that a taxable distribution from your IRA, which can also involve early withdrawal penalties. In our conversations with account holders, over 35 percent of the policies were in the IRA holder’s name rather than the name of the IRA.
[Related: Real Estate IRA Rules]
About Bill Mecklenburg
Bill Mecklenburg is President of SES Risk Solutions, a subsidiary of Alliant Insurance Services. Bill was previously the CEO of Redwoods Managers, Inc. and the COO of The Redwoods Group, a specialty insurance organization that The Wall Street Journal and the nonprofit organization Winning Workplaces selected as one of 15 winners of the 2008 Top Small Workplaces. Bill also served as a Managing Director of reinsurance broker Guy Carpenter and he was an SVP and the leader of the Property & Casualty Division of KEMPES, Inc. Bill has an Economics degree from the University of California, Berkeley.
About SES Risk Solutions
SES Risk Solutions is a leading provider of insurance services for real estate portfolios. SES currently services over 50,000 properties for fiduciaries, owners, and managers through master policies on a nationwide basis. SES has a 30-year history of offering competitive and comprehensive insurance products complemented by unparalleled service and technology platforms for properties (residential, commercial, farm, and land) held in trust by financial institutions or owned by real estate investors.
I plan to purchase a rental property with my IRA. Does the rental income have to go back into my IRA?
Bill Mecklenburg is not an employee of Equity Trust Company. Opinions or ideas expressed are not necessarily those of Equity Trust Company nor do they reflect their views or endorsement. These materials are for informational purposes only. Equity Trust Company, and their affiliates, representatives and officers do not provide legal or tax advice. Investing involves risk, including possible loss of principal.
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