When and How to Hold Real Estate in an IRA

Individual Retirement Accounts (IRAs) can legally hold real estate under certain conditions, which sounds like a great idea to many people. It’s important to understand when it’s right to make this kind of investment and the requirements that go along with it.

Talk to Your Custodian

The custodian that holds your IRA funds has rules that must be followed to ensure that you don’t run into trouble with your IRA. Always discuss the limitations of your IRA investments with your custodian first to see what is available to you. If you do have the ability to invest your funds in real estate, the next hurdle will be to avoid prohibited transactions. IRA funds are tax deferred, until a prohibited transaction occurs, which can make the funds fully taxable.

Ensure Your IRA is Self-Directed

For an IRA to hold real estate, it must be a self-directed IRA. Typical IRAs are not self-directed and are limited to stocks, bonds, mutual funds, and CDs as the investment options. An IRA can easily be moved to a custodian that offers “self-directed” as an option. Self-directed IRAs allow the owner more control over the investments and adds more options such as real estate, notes, and tax lien certificates to the list.

Know the Restrictions

Once an IRA is self-directed, there are several more requirements and rules for investing in real estate. Many people have the initial thought that they can purchase a vacation home with their IRA funds and it’s a win-win situation. Unfortunately, this would be a prohibited transaction. Here are some of the basic rules regarding real estate in an IRA:

  • Property Taxes, Mortgage Interest, Depreciation, and other deductions related to the real estate cannot be taken on the owner’s tax return
  • The real estate is owned by the IRA, so all expenses and repairs related to the property must be paid with IRA funds
  • You cannot work on the property yourself, you must hire a contractor to do any repairs. If you wish to rent out the property, you must hire a property manager to oversee the tenants
  • You or your relatives cannot occupy the property. The real estate cannot be bought or sold to or from yourself or any family members

The main point to remember is that the investment must be an arm’s length transaction and cannot be used for personal benefit. If any rule is broken, the full value of the IRA can become fully taxable and an additional 10% penalty may be assessed depending on your age.

Is it Right for You?

So, when is it right to hold real estate in an IRA? It’s smart to invest in real estate with IRA funds when you have some prior experience investing in real estate. People can often earn nice returns through buying and flipping real estate or just accumulating rental properties and having a management company oversee the properties. Conducting the IRA in this way can be a great way to accumulate wealth, but it is not for everyone, and it must be done carefully.

If you are interested in moving forward with investing in real estate with your IRA funds, contact an Anders advisor to advise and help with compliance requirements. Learn more about the pros and cons of holding real estate in an IRA.