Using a Self-Directed IRA to make real estate investments can be particularly advantageous from a tax and investment perspective in many instances. This article will explore the specific situations where one should undeniably look to use an IRA to buy real estate.
When Should You Invest IRA Funds in Real Estate?
When Seeking Long-Term Wealth Growth
By purchasing real estate with a Self-Directed IRA, you can defer taxes on rental income (traditional IRA) or avoid taxes altogether for qualified Roth IRA distributions. If you’re focused on long-term asset appreciation and consistent income generation from an asset without immediate cash flow needs, this is a good way to maximize the tax benefits, especially if the income is steady and considerable
When You Have an IRA with Substantial Assets
With over $13 trillion of IRA funds as of 2024, millions of Americans are “IRA rich.” If you are smart enough to save via retirement plans, then you have likely accumulated substantial savings. A Self-Directed IRA will offer you the chance to better diversify your retirement portfolio beyond traditional stocks and bonds by purchasing income-generating real estate.
An “SDIRA” gives you control over a broader range of asset classes. This makes sense for investors who want to use IRA funds to acquire physical assets that have the potential to appreciate, especially if they believe the real estate market offers better returns than traditional investments.
You have the opportunity to generate tax-advantaged income as well as benefit from tax-free appreciation on the sale of the real estate. Investing in real estate can help diversify your IRA away from the volatility of Wall Street while giving you the peace of mind that your IRA owns a hard asset.
When You Can Pay for the Property in Full
For real estate investors who have enough in their IRA to buy the property outright (without financing), using a Self-Directed IRA is a home run. Obviously, the more you income/assets can shelter from taxation, the better!
On the flip side, when using an IRA to purchase real estate, taking out a mortgage complicates the process due to the UBTI tax that applies to income generated by the leveraged property. In addition, Internal Revenue Code (IRC) Section 4975(c) does not allow an IRA to secure a traditional mortgage. An IRA must use a non-recourse loan, which is a loan that is not personally guaranteed by the IRA owner. Paying for the property in full avoids this tax and simplifies the transaction, making it an ideal strategy for those with significant IRA assets.
When You Are Not Relying on the Property for Immediate Personal Use
If the IRA owner is focused on owning the real estate asset for investment purposes only and is not interested in using the property for personal use until after retirement age, then using a Self-Directed IRA to buy the property is a great option.
The IRS prohibits personal use of real estate held in an IRA. Disqualified persons, including yourself, your spouse, and lineal decadents and ascendants, cannot utilize the property while it’s owned by the IRA. If you’re looking to buy a vacation home for immediate use, an IRA isn’t the right vehicle. However, if you want to hold the property, or rent it out to third parties, the Self-Directed IRA real estate strategy works brilliantly.
When then time comes, you can sell the property from the IRA to yourself and then own it personally. This is an in-kind distribution of the plan. Taxes will be due, unless you are making a qualified Roth distribution. At that point, you can use the property to your heart’s content!
When Real Estate is a Core Component of Your Diversified Retirement Strategy
Experienced real estate investors understand the economics of a real estate transaction and are typically very keen to use an IRA when they learn of the opportunity. The primary reason more real estate investors are not using their retirement funds to invest is that they simply are not aware of the solution. Thankfully, over the last several years, the Self-Directed IRA has grown dramatically in popularity.
Real estate investors understand how real estate can act as a hedge against inflation and provide diversification, reducing overall portfolio risk. For those with expertise in real estate and a long-term view on retirement planning, using a retirement plan to invest is a natural choice and an option that makes the most investment and tax sense.
When You Don’t Need the IRA Funds for Liquidity Before Age 59 ½
If you are an investor that understands the importance of long-term retirement planning and are confident you won’t need the funds for immediate cash needs, you can hold the property in the IRA until the age of 59 ½.
Withdrawals from an IRA before age 59 ½ are generally subject to a 10% early distribution penalty and ordinary income tax. If the property is owned in a Roth IRA, no taxes or penalties will be due at that age! If you’re not concerned about liquidity and shouldn’t need to sell the property or use the cash, holding real estate in a Self-Directed IRA will likely prove to be an effective long-term investment and tax planning strategy.
Key Considerations for Using an IRA to Buy Real Estate
If you are looking to use an IRA to buy real estate, below are some key considerations. Note – picking the right custodian is so important because selecting the right solution is so important.
- Self-Directed IRA: You need to work with the right IRA custodian that allows one to make alternative asset investments, such as real estate.
- IRS Prohibited Transaction & UBTI Rules: Disqualified persons cannot use the property, manage it personally, or receive any direct benefit until the IRA is liquidated. Additionally, if one uses leverage to buy real estate with an IRA, the loan must be non-recourse and the use of leverage could trigger the UBTI tax.
- Real Estate Expenses: All expenses related to the property (maintenance, repairs, taxes, insurance) must be paid from the IRA, not personal funds. Thus, it is important to make sure there’s enough cash in the IRA to cover these costs or you have the opportunity make additional IRA contributions.
Conclusion
It’s crucial to weigh the potential liquidity risks, costs, and IRS regulations before committing IRA funds to real estate. The decision should align with your financial goals, risk tolerance, and overall retirement strategy. Outlined above are the best reasons of when to make real estate investments in an IRA.
