You can buy real estate in your IRA. In some select cases, that might be a smart move, but for the average person, it is probably not a great idea. There are a number of rules that have to be followed in order to legally purchase real estate with funds in an IRA account.
- In general, only experienced real estate investors and house-flippers should consider buying real estate in their IRA.
- There are many rules to follow when buying real estate in an IRA, and failure to follow every rule could result in your entire IRA losing its tax-deferred status.
- Real estate held in an IRA must be strictly an investment, and it can't be used in a personal way, such as renting it out to family members or vacationing in the home.
- While holding real estate in an IRA will defer taxes on rental income, it also prevents you from claiming losses, depreciation, or any other tax write-offs.
The Basic Rules
The funds in your IRA are tax-deferred. If you buy real estate with an IRA improperly, you can disqualify the IRA, which makes all of your funds taxable. That would be an expensive mistake. Here are the basic rules that must be followed to have a qualified real estate purchase in an IRA.
- You can’t mortgage the property.
- You can’t work on the property yourself—you must pay for an independent person to do any repairs.
- You don’t get the tax breaks if the property operates at a loss, nor can you claim depreciation.
- You must pay all costs associated with the property out of the IRA and deposit all rental or other related income into the IRA. If you don’t have enough cash in your IRA, and a major property expense comes up, that can put you in a bad situation.
- You cannot receive any personal benefit from the property—you can’t live in it or use it in any way. The real estate owned by your IRA must be strictly for investment purposes.
No Personal Use
When people first hear that they can legally buy real estate with IRA money, they get excited, thinking they can use their IRA funds to buy a vacation property or a house they might rent to their children. Unfortunately, the IRS rules prevent it from working that way.
Any investment made by your IRA must be considered an arm's length transaction, as if you were dealing with a stranger. That means you can’t use money in your IRA to buy or sell real estate to or from yourself or family members, and you can’t receive any personal benefit from the property. It can’t be a piece of property that you use for yourself in any way, shape, or form.
You can't receive any indirect benefit either. For example, you can’t pay yourself or a family member to be the property manager. To do things by the book, you’ll be required to hire an independent person to do any maintenance or repair work needed.
The Tax Benefits
Like any investment in your IRA, taxable income is deferred until the day you take withdrawals, or if it is a Roth IRA, any investment gains accumulate tax-free, and you are able to withdraw this money tax-free. These rules apply no matter what type of investment is owned in the IRA.
One of the main benefits of investing in real estate is depreciation—a current tax deduction you get to take. However, inside your IRA, you cannot claim deductions, depreciation, or a loss. You don’t get these big tax write-offs with real estate held inside of your IRA.
In addition, for a traditional IRA, once you reach 70 1/2 you must take required minimum distributions. If you own real estate, you can't usually sell it off in portions, so if there is not enough cash in your IRA account to cover your required distributions, this requirement can cause problems.
For all of these reasons, most people are better off using non-IRA money for their real estate investments. The exception is the Roth version of the IRA. If you are a savvy real estate investor and can use Roth IRA funds for your purchases, you may be able to accumulate substantial gains, which would all be tax-free, which may be a smart move.
Who Should Buy Real Estate in Their IRA
If you are an experienced real estate investor, and you know you can earn attractive returns by buying raw land, flipping properties, or accumulating rental real estate, then using IRA funds may make sense for you. You must defer withdrawing income or gains until age 59 1/2, but inside the IRA you can roll funds from one project to the next with no tax consequences.
Finding a Custodian for Real Estate IRAs
As IRAs have special tax benefits, an IRA must have a custodian who keeps track of, and reports to the IRS on, deposits, withdrawals, and year-end balances.
Many custodians will allow you to open what is called a "self-directed IRA." They charge an annual or quarterly fee to provide the necessary reporting. Many of these custodians provide literature and links to the IRS rules that apply, but most of them will not give you legal or tax advice, meaning that it's up to you to make sure you are following the rules.
If you don’t follow the IRS rules, you are taking the risk that your entire IRA account will be considered taxable income.