Using Your IRA to Invest in Real Estate

photo of word IRA in keyboard

When thinking of IRA investments, most people think of stocks, bonds and mutual funds as the only possible options. But it is also allowable to use your IRA to invest in real estate. The key word here is “investment”– this isn’t a way to buy a personal residence for you or a member of your family.

It is, however, a way to use the funds in your IRA to buy real estate without having to take a current distribution, which eliminates the immediate tax consequences of doing so. It also provides a way of diversifying out of traditional IRA investments.

So What’s Involved in Using an IRA for Real Estate?

As with all IRA accounts, the rules are strict. The basics are:

  • You and your relatives are prohibited from occupying or working on the property.
  • The money and real estate will be held in a Self-Directed IRA.
  • Only investment real estate qualifies.
  • There can be no “self-dealing”.
  • The IRA will hold title to the real estate
  • Property management is done through the IRA
  • It can be any type of IRA

Self-Directed IRAs and Real Estate

Not all self-directed IRAs are created equal when it comes to holding real estate. A Self-Directed IRA can be set up through a custodian, but not all custodians are set up to handle non-traditional asset IRAs.

You’ll need to find one who does and then transfer your IRA funds into a Self-Directed IRA account so you can use the money for the transaction. The easiest way is a direct transfer from one custodian to the next, but be very careful to follow the IRS rules about moving funds from one IRA account to another.

Things to Consider with a Real Estate IRA

The major advantage is that you can diversify your IRA holdings beyond traditional investments. And by “unlocking” those funds, it also may allow you to pursue transactions you otherwise could not consider.

As with all real estate investments, the Return on Investment (ROI) and cash flow analysis will be key. If you have a real estate investment in mind, you’ll need to run the numbers taking into account the tax advantaged nature of an IRA to know whether it is right for you.

If the numbers work, using your IRA can be a solid option for investment real estate. It’s about picking the right property deal and doing the proper analysis.

A few of the items to consider are:

  • ROI calculations include tax advantaged items such as depreciation. In an IRA, that is moot.
  • Financing real estate in an IRA can be difficult, although not impossible.
  • In an all cash purchase, the total return impact from leverage disappears.
  • Real estate is not liquid, so if you need those IRA funds soon take that into account.
  • IRA distributions are taxed at the regular income tax rate, not the capital gains rate.

Know the Rules and Don’t Break Them

The IRS rules on doing this kind of transaction matter, so having proper advice is critical. If you accidentally “break” the IRA, you will end up with a very unpleasant tax consequence.

Do your due diligence with legal and tax advisers who understand these regulations before taking the plunge so you don’t have any unintended consequences or issues with the IRS.