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Should I Invest My IRA In Real Estate?

Investing money in an IRA account gives incredible asset flexibility. Unlike a company-sponsored 401(k) plan, investing in an IRA does not limit you to a select menu of mutual funds and investment products. In fact, IRA funds can be invested in a wide variety of financial investments ranging from individual stocks and bonds to real estate, business interests, commercial properties, hotels, apartment units, storage facilities, and others.

There are pros and cons to these types of investments and ultimately they require some structural changes within the IRA itself, but they can instantly add diversification and return to an IRA portfolio if done properly!

How Do I Invest My IRA In Real Estate?

First things first. In order to purchase a property in your IRA account, you must setup a self-directed IRA account with a custodian that allows these types of investments. This custodian will be responsible for the record-keeping and IRS reporting requirements of each individual investment inside the IRA. Usually, the custodian offers these self-directed IRA accounts and handles this reporting in exchange for an asset-based fee or percentage of the value of the investments themselves.

Once a self-directed IRA has been established with a qualified custodian, you will then work with that custodian to navigate the rules associated with the purchase and maintenance of the property itself. It is important to note that the IRA will be the owner of the property...not you. This distinction is important as we will discuss what that means and how it affects the investment here shortly. Just remember that the property must be titled and deeded to the custodian for the benefit of your IRA account. It will not be held in your name.

Once Purchased, How Does The IRA Interact With The Property?

One very strict and important rule governing IRA ownership of real estate is that the real estate must be an investment....it cannot be used for personal use. You can’t use it to purchase a property you intend to run your business out of. You can’t use it to purchase a vacation property. The purpose of the investment is to generate return that helps fund your eventual retirement. That’s all.

The investment property also cannot benefit family members such as kids or grandchildren. It cannot be used by your spouse. You also cannot use the IRA to purchase a property you already own. This is considered a self-dealing transaction and is prohibited.

Because the tax status of the IRA allows for tax-deferred growth, all funds and income must remain in the IRA or else they are subject to IRA withdrawal taxes and penalties. For instance, if a property is purchased and rents are collected from tenants of the property, those rent dollars must be paid directly to the custodian of the IRA account. The funds can continue to collect inside the IRA until you have reached a qualifying retirement age. Also, the entire value of the IRA will be subject to Required Minimum Distributions (RMD’s) once the IRA owner reaches an appropriate age.

Is Investing In Real Estate Inside My IRA A Good Idea?

At the end of the day, the goal of IRA investments is to generate a return that helps fund your eventual retirement. If you identify a real estate investment that can generate great returns for your IRA dollars, then yes, it can be a great investment!

However, if faced with a decision of whether or not it makes sense to purchase an investment property with IRA dollars or to purchase that property in your own name in a traditional cash purchase, there are some things to consider.

  1. Purchasing real estate inside an IRA account disqualifies you from some of the tax advantages of investing in real estate in the first place. Since everything is treated as taxable income, you lose the ability to itemize deductions such as mortgage interest deductions, insurance deductions, depreciation, etc.
  2. Real Estate in an IRA can never be used for your own benefit. There is far more flexibility if the property is owned by you outright and not by your IRA account. Especially if the property is in a location you might like to visit with your family such as a vacation property.
  3. When you need to make repairs or have maintenance-related expenses, they must be paid for with other dollars from your IRA account. You cannot pay for those expenses with dollars in your own name. This is important and your custodian will help with the record keeping and distribution of these payments.
  4. Custodian fees need to be factored into the return calculation before you make your investment. These custodian services can be pricey and you need to make sure they are accounted for when deciding whether or not you want to undertake a purchase in this type of account.
  5. Real estate is an illiquid investment. For instance, if your property needs a new roof, you’ll have to maintain a cash bucket inside your account to pay for that roof. Selling the property is likely something you’ll want to avoid. IRA contributions are limited and may not even be available to you depending on your income. You’ll have to plan accordingly when you set your investment up.

Even with these considerations, we always tell clients that a rate of return is a rate of return. If you can identify an opportunity to generate a return that might be greater than what you would expect from a standard mix of equity investments, then it is absolutely worth considering. In addition to generating return, it can be smart to own an investment that doesn’t rise and fall with financial markets in a cyclical nature. Owning real estate can provide some diversification of asset-type to your overall portfolio. 

If you have any questions about whether or not real estate ownership inside your IRA account would be right for you, we would be happy to help! Schedule some time for us to connect and we can discuss this strategy in conjunction with your comprehensive financial plan.