Real estate is a popular retirement investment among self-directed IRA investors. While purchasing real estate within an IRA has been around for many years, finding an IRA provider who is willing to service this type of investment is challenging. That is why it’s important to do your homework, understand the regulations, and talk to an experienced provider who can walk you through every step of the way.
While IRA custodians cannot give advice about specific investments or strategies, they can point out potential legal issues, provide answers to your questions, and offer a number of educational resources. If you are considering diversifying your portfolio and adding real estate to your IRA or Roth IRA, be sure to do your research and find a reputable custodian to work with.
Benefits of Real Estate in an IRA
An IRA can purchase many types of real estate, including residential, commercial, raw land, and agriculture. You are able buy, sell, and exchange properties in a tax advantaged account. Earnings and appreciation from real estate property are tax-deferred if held in a Traditional IRA and have the potential to be tax-free if held in a Roth IRA.
Real estate investing also offers multiple investment strategies, including “buy-and-hold” or “flip-and-sell.” In addition, there are multiple options for funding your real estate investment. This includes direct purchases, partnering with other investors, and leveraging with a non-recourse loan. Before investing, it is also important to know the risks and potential pitfalls of owning real estate within an IRA. Speak with an attorney, tax accountant, or investment professional before investing. Internal Revenue Code (IRC) 4975 outlines prohibited transactions to consider before deciding to hold property within a retirement account.
How a Real Estate IRA Works
An IRA is its own financial and legal entity, separate from your personal portfolio. As a separate legal entity, your IRA will have its own name. The IRA is the owner of the real estate, not the IRA holder. All legal documents related to an IRA-owned asset must be in the name of the IRA, not your personal name.
All expenses for the property must be paid by the IRA. Expenses may include, but are not limited to, earnest money, closing costs, appraisal fees, insurance, maintenance, property taxes, etc. Rent from income producing property must be made payable and deposited to the IRA. Documents associated with your IRA’s real estate investment need to be registered to and signed by the custodian of your account to meet IRS guidelines.
Real Estate Options You Can Own
Farmland and vacant ground are two popular real estate investments held in IRAs. Other potential investment types include residential real estate, such as single or multifamily properties, condos, and apartments. Commercial real estate, such as office buildings, retail shops, and convenience stores may also be held. Self-directed IRAs may also invest in vacation homes, resort property, trust deeds, and mortgage notes. Timeshares and mobile homes that aren’t affixed to the property are some examples of real estate products that cannot be held in an IRA.
IRA Restrictions & Prohibited Transactions
It’s important to understand all the rules governing IRA investments. The IRS requires IRA real estate to be for investment purposes only and has rules regarding how real estate can be purchased and used. IRC 4975 also provides a list of disqualified persons that your IRA cannot transact with. It is important to understand these rules and the IRS definition of the term “disqualified persons.”
Disqualified persons are people who cannot benefit from the property owned by the self-directed IRA. This includes the account holder, his or her parents, grandparents, great grandparents, spouse, children, grandchildren, great grandchildren, or any of their spouses. These are called “lineal ascendants and descendants.” For example, you cannot rent a flower shop owned by your IRA to your child. IRC 4975 has a full list of disqualified persons.
When purchasing real estate within an IRA, it is important to consider how you plan to use the property. A self-directed IRA cannot own any property that is used for the personal benefit of the account holder or any disqualified person. For example, you cannot run your business out of a building owned by your IRA or live in a house owned by your IRA. If an IRA owner engages the IRA into these types of transactions, it could lead to a disqualification of the IRA and an immediate distribution of the entire account with possible taxes and penalties incurred. So, while it is appealing to purchase a vacation home with IRA funds and stay in one week a year, doing so could be detrimental to the IRA.
Conclusion
The list of prohibited transactions can make a real estate IRA sound scary, and make some people wonder why they would want to take this approach. When considering this option, it needs to be looked at like any other IRA investment, something that is solely for investment purposes and being used to build saving for retirement. Instead of going all in in the stock market, would it make sense to purchase a rental home and have that income flow into the IRA tax deferred? Or purchase some farmland that is rented out and hopefully building value? These are all important things to consider and could be of huge benefit for the right investor.