Can I Invest My IRA in Real Estate?

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House with for sale sign

The U.S. Labor Department reported on February 15, 2017 that the annual inflation rate for 2016 was 2.5%. That means that returns on many types of investments, such as bank CDs, money market funds, municipal bonds, and treasuries (two to ten-year terms), are lower than the rate of inflation.

Meanwhile, the real estate market in the United States has rebounded from the economic collapse of 2008. Prices of real estate, in vibrant markets, are now at levels higher than they were prior to the real estate market crash. Quality properties, in major markets, are showing solid annual increases in valuation.

These trends are encouraging for more investors to consider using IRA funds for direct investment in real estate, especially income-producing properties.

IRA-owned real estate increases investment portfolio diversification. Taxes on earnings and capital gains for a traditional IRA are deferred until you withdraw from the IRA account, and certain IRAs even allow assets to be transferred to beneficiaries after death, with limited or no taxes.

A Self-Directed IRA Can Legally Own Property

A self-directed IRA can invest in real estate. For example, you can use this type of IRA to renovate properties for resale or to make loans to contractors and/or other real estate investors. In addition, a self-directed IRA may own commercial and rental real estate property as an investment.

Learn about the 4 advantages of a self-directed IRA here.

The investment of IRA funds in real estate must be made through a company that specializes in working with self-directed IRAs to make investments in real estate.

This company serves as the custodian for the IRA funds and as the trustee that manages the investment. It is important to choose this company carefully. They are responsible for the administration of the IRA, IRS filings, and providing regular account statements to you.

The custodian company will also inform you of the rules and regulations regarding IRAs, such as:

  • Annual contribution limits
  • Tax deduction rules
  • IRA funds distribution rules
  • Penalties for early withdrawals of IRA funds
  • Any changes to these rules and regulations

Avoid Self-Dealing

Any funds withdrawn from a self-directed IRA that are used for self-dealing are subject to early withdrawal penalties, and the withdrawals are treated as taxable income.

Certain prohibited activities may create a large, sudden tax liability on all the IRA funds in the account, so extreme caution needs to be taken in order to avoid this serious problem.

Some examples of self-dealing include:

  • Using IRA funds to purchase or invest in your own house
  • Using IRA funds to invest in a property where you reside (for example, a small apartment building where you live in one of the units)
  • Using IRA funds to invest in a property partially owned by a family member or a property that is lived in by a family member
  • Paying the IRA account holder or a family member for any services, maintenance, or repairs for the property

No Mortgages, No Deductions: IRA Funds Pay All Expenses

An IRA cannot borrow funds to acquire properties using a traditional mortgage.

Instead, an IRA may acquire an interest in a property that has an existing loan; however, this requires an annual property appraisal to determine the value of the portion owned by the IRA.

The appraisal process is so complex and costly that most do not bother with this strategy. As a result, IRA-owned properties are typically purchased with all cash and have no mortgage deduction to offset any income earned by the IRA-owned properties.

Moreover, if the IRA account holder receives funds that are considered regular income, such as dividend payments, then this may trigger taxes, interest, and penalties.

In addition, there is no depreciation deduction for the IRA-owned real estate. Because IRA funds are not taxed, there is nothing to deduct depreciation from.

The IRA-owned real estate cannot be used as collateral to take out another loan. Any expenses for the IRA-owned properties must be paid by IRA funds. This requires maintaining a sufficient cash balance in the IRA account to cover all contingencies.

Investing IRA Funds in Real Estate

Investing IRA funds in commercial or rental real estate is the direct investment of those funds in the specific real estate that will be owned by the payee.

However, with an REIT (Real Estate Investment Trust), investors buy shares or ownership units, which may be either a public or a private company. This ownership gives the investor a proportional ownership interest in the entire real estate portfolio owned by the REIT.

A typical portfolio for a REIT may contain many properties. The large public REITs may own thousands of properties.

Contact the financial experts at BP Financial today to see if using your IRA for investing in real estate is right for you.

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