Despite what you might have heard, you can use an IRA to invest in real estate, but you have to be really careful.
The IRS has strict rules you must follow when investing in real estate with an IRA. If you don’t follow them, you risk disqualifying your IRA and making its funds taxable.
Here’s what you need to know about IRA real estate investments:
IRA real estate investment rules
To buy real estate with an IRA, you must adhere to the following IRS rules:
- You cannot get a conventional mortgage for your investment property, nor can you use non-IRA money to help finance it. You can get a non-recourse IRA loan.
- You must pay unrelated-business income tax (UBIT), if you finance your investment property.
- The property must be an investment; you can’t use it for anything else, and you and your family can’t live in it.
- Your IRA must assume all property expenses, including taxes, repairs, and other fees.
- You cannot maintain the property yourself. Your IRA must pay for a third party to do so.
- Your IRA must collect all revenues from the property.
- You cannot claim tax breaks for deductions or if your property operates at a loss or depreciates.
Pro tip! Since your IRA must pay all property expenses, make sure there are enough funds in it to cover expensive surprises before you buy real estate with it.
In essence, you can only make arm’s length transactions when you invest with an IRA. In other words, you can’t buy or sell property for personal and familiar use whatsoever.
Why should you use an IRA to buy real estate?
Seasoned real estate investors know they can take advantage of their IRA’s tax benefits to make attractive returns on their real estate investments. All IRA investments, real estate included, accumulate gains tax deferred — that is, you won’t pay income tax on your gains until you withdraw them in retirement. With a Roth IRA, your withdrawals in retirement are tax-free (see below).
How do you buy real estate with an IRA?
To start buying real estate with your IRA, you’ll need to find a custodian who’ll allow you to open a self-directed IRA (SD-IRA).
SD-IRAs allow you to invest in more options — such as real estate, precious metals, bitcoin, and even art — than regular IRAs do. Every year, you must report the value of your investments to your custodian, the financial entity responsible for auditing your IRA, making sure you follow IRS rules, and reporting to the IRS.
Before you open your SD-IRA, you’ll have to find a custodian. Note that custodians won’t be able to offer you guidance on what real estate purchases you should make, so do your research. Head over to our guide on investing in real estate to help you decide what to buy!
Should you use a Roth IRA to invest in real estate?
You can use a Roth IRA to invest in real estate. Roth IRAs are a bit different from traditional IRAs. You make contributions to your Roth IRA with after-tax dollars, meaning your withdrawals in retirement are tax-free. Thus, you won’t pay taxes twice for your contributions. Funds also grow tax deferred, just as they do in traditional IRAs, giving you a double tax advantage.
You’ll receive Roth IRA tax benefits only on the part of the property you paid for — the equity, in other words. You’ll receive total Roth IRA tax benefits only if you purchase your investment property with 100 percent Roth IRA funds.
The bottom line
Using an IRA to invest in real estate is tricky; in fact, most who do so are experienced real estate investors. If this is your first time, talk to a real estate agent or certified financial planner. It’ll save you a major headache and lots of money to have your questions answered.
