Rae Hartley Beck first started writing about personal finance in 2011 with a regular column in her college newspaper as a staff writer. Since then she has become a leader in the Financial Independence, Retire Early (FIRE) movement and has over 300 by.
Rae Hartley Beck Deputy Editor of Investing and RetirementRae Hartley Beck first started writing about personal finance in 2011 with a regular column in her college newspaper as a staff writer. Since then she has become a leader in the Financial Independence, Retire Early (FIRE) movement and has over 300 by.
Rae Hartley Beck Deputy Editor of Investing and RetirementRae Hartley Beck first started writing about personal finance in 2011 with a regular column in her college newspaper as a staff writer. Since then she has become a leader in the Financial Independence, Retire Early (FIRE) movement and has over 300 by.
Rae Hartley Beck Deputy Editor of Investing and RetirementRae Hartley Beck first started writing about personal finance in 2011 with a regular column in her college newspaper as a staff writer. Since then she has become a leader in the Financial Independence, Retire Early (FIRE) movement and has over 300 by.
| Deputy Editor of Investing and Retirement
Updated: Feb 13, 2023, 1:15pm
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An individual retirement account makes it simple to invest in assets like stocks, bonds and exchange-traded funds (ETFs). But there’s a special type of IRA called a self-directed IRA that lets you own alternative assets like real estate.
For some people, a self-directed IRA could be a way to invest tax-advantaged retirement funds in real property. But there are tons of rules governing everything from property ownership and usage to how you cover expenses and take profits. Inexperienced investors can easily run afoul of the IRS.
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On Datalign Advisory's WebsiteA real estate IRA is just another way of calling a self-directed IRA that’s designed to hold investment property.
You can own a wide range of property types in a real estate IRA, including land, single and multi-family homes, international property, boat docks, commercial properties and more.
Since this is a type of self-directed IRA, the custodian—the company safeguarding your account and enforcing IRS regulations—allows you to hold alternative asset classes like real estate.
The first step to using a real estate IRA is to find a custodian that allows or even specializes in real estate IRAs. Unfortunately, many of the top IRA custodians don’t dabble in real estate IRAs.
Custodians that work with real estate IRAs typically charge higher fees than regular IRA custodians, so remember to factor in those costs.
Once you open a real estate IRA, you’ll need to fund your account—typically with a rollover from an existing IRA. With your cash in place, you can buy real estate and have it titled in the name of your IRA.
You don’t necessarily have to come up with a giant pile of cash to buy a property outright. You can finance real estate in your IRA with an investment property-specific mortgage. Then, you can pay the mortgage using additional cash from your self-directed IRA.
When you sell a property held in a real estate IRA, the funds remain in the account. Depending on the type of IRA you’ve selected, those funds grow tax-deferred (traditional IRA) or tax-free (Roth IRA).
While a real estate IRA lets you diversify away from stocks and bonds, there are a wide range of special rules governing this specialized type of account. Here are some of the key rules to understand, so you don’t run afoul of IRS regulations.
Real estate that is held in a self-directed IRA is owned by the account, not by you personally. That means the title documents that confirm ownership of the property are in the name of your IRA, rather than in your name. A typical title would read something like “[Custodian name] FBO [your name] IRA.”
All expenses and income flow into and out of your real estate IRA. All property taxes, utility bills and other expenses are paid by your account. All rental income or other income is paid back into your account.
If you have dreams of you or your family living in real estate owned by your IRA, banish the thought. Real estate held in a self-directed IRA can only be an investment property.
Under the IRS rules, you and any member of your family—plus any of your beneficiaries or fiduciaries—are referred to as disqualified persons. Since the purpose of an IRA is retirement investing, these disqualified persons can’t make use of the real estate assets.
If you need to fix up or repair property held in a real estate IRA, the account must pay for the work. It can’t be performed by a disqualified person—that’s you.
You can’t sell, lease or exchange property you already own to your real estate IRA. Doing so is called “self-dealing,” which the IRS strictly prohibits.
If you take out a loan that’s secured by the property itself—a so-called non-recourse loan—you’ll have to pay unrelated business income tax (UBIT) on any profits related to the financed portion.
For example, if you have a $1,000 annual profit and 50% of the property’s value is financed, you’ll owe UBIT on $500.
Fortunately, you can use depreciation and operating costs to reduce your tax bill. Doing so can allow you to reduce your UBIT or eliminate it altogether. You’ll need to work with a qualified accountant who understands these unique rules, so add in their costs when considering a self-directed IRA.
Given the wide range of REITs and real estate funds that are available, all of which spread risk across multiple properties, why would investors opt to hold property in their IRA?
According to Mallon FitzPatrick, a certified financial planner (CFP) in New York City, there are a couple of situations where a real estate IRA makes good sense:
There are situations where a real estate IRA is more a hindrance than a help.
If you’re set on using a self-directed real estate IRA for real estate investing, here’s a simple four-step process to get you started:
Research different real estate IRA custodians and open an account. You’ll need to decide what type of IRA to open (traditional, Roth, SEP) at this time.
You’ll fund either with cash up to the annual contribution guidelines or through an IRA rollover. Rollovers must be like-to-like, or between two IRAs of the same type. If rolling over funds from a traditional IRA into a self-directed Roth IRA, you’ll need to do a Roth conversion and pay the necessary taxes.
Review the IRS guidelines to ensure that the property you buy and its intended use and inhabitants don’t break any rules. As with any other real estate purchase, do your due diligence before entering into a purchase agreement or applying for a mortgage.
Decide how you’ll pay—cash purchase or financing—and proceed with escrow. Remember that all funds for the purchase must be paid or wired by your real estate IRA.
Once escrow is closed, you can rent or lease the property—so long as it’s not to a disqualified person. Then, your real estate IRA must pay all expenses and receive all income.
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