Real Estate IRA Investing FAQ

Can I buy real estate in my Retirement Plan?

Yes, the IRS actually places very few limits on what you may buy with your IRA retirement funds. It is your IRA custodian who has put those limits on your retirement account. Truly self-directed IRAs allow you, the investor, to choose your investments.

Can I borrow funds to buy real estate in my IRA? Can my IRA get a mortgage?

IRAs can invest in all types of real estate!

Yes, many banks have discovered the demand by IRA owners to finance real estate purchases in their IRAs. Banks continue to develop products specifically for IRAs and other plans. You’ll need a non-recourse loan, which tend to have higher down payment requirements than those for personal homes, but these loan types are available at many banks.

Do I need an LLC to purchase real estate with my IRA?

An LLC may be used to purchase real estate, but it is not required. Your IRA can purchase a property in the very same way as you would personally. This is the most common way real estate is purchased and in this situation the property is simply titled to your IRA.
 
Do I need to use a special broker and title company?

No special broker or title company are required—you can use the same ones you used to buy your current home or any other broker. However, using a broker that is familiar with this process may be helpful buy it is not required.
 
Can I repair the property myself?

You may not personally do any work on the property and neither can any other disqualified persons (IRA holder, his spouse, his parents and grandparents, children and grandchildren, their spouses, certain fiduciaries and any entity owned or operated by a disqualified person. Work can be done by anyone else and you still have control over what you want them to do. For instance, you can’t personally paint the walls but you can tell the painter how you want the house painted.
 
Can I partner my IRA with my personal funds? Who else can I partner with?

If you cannot afford the investment property you are interested in you have many options. One option is to partner with yourself. For example your IRA can own 50% and you can personally own 50% (note: even if you personally own 99% of the property you are still prohibited from living in it or using the property.) You may also partner with someone else’s personal or IRA funds; the disqualified persons rule does not apply here so you may partner with your spouse, parent, child, friend, or whomever. There is no limit to how many people you can partner with. The percent of ownership cannot be changed once the investment is made.
 
Do I have to pay capital gains taxes if I sell the property?

Because the property is owned within a tax deferred (Traditional IRA) or tax free (ROTH IRA) plan no capital gains taxes need to be paid.

Can I take property as a distribution and then live in it?

Yes, after you reach 59.5 years of age you may choose to take the property as a distribution from your IRA. Once the property is 100 percent in your possession, you are free to use the property as you wish.

Can I be the property manager for my IRA-owned real estate?

Many self-directed investors who call our office ask, “Can I act as the property manager for my IRA owned real estate?” The answer is yes, but there are several rules that must be followed in order to comply with IRS guidelines.

1. Do not handle the finances of your IRA owned real estate personally.

Example: Pay bills or expenses out of pocket, have rent checks made out to you personally, etc.

Facts: When investing in real estate with your IRA, you are not the investor. The IRA (a legal entity) is the real investor and title to the real estate is most likely held in the name of the IRA (Example: NDIRA, Inc. FBO Client Name IRA). This is a tough concept for some investors to grasp because it can be difficult to conceptualize who is really investing.

2. You are allowed to be the decision-maker.

Example: Selecting contractors, choosing fixtures, screening tenants, etc.

Facts: You are ultimately the decision-maker for all investment related decisions. However, IRS code prohibits you from personally adding sweat equity to the property. This means that you are not permitted to perform repairs or upgrades; they must be done by a non-disqualified person and paid for by the IRA. To the IRS, value-added services that are personally rendered constitute a contribution that cannot be taxed and are therefore disallowed. The bottom line is that your IRA must have access to an adequate cash buffer necessary to pay all expenses related to the property.

3. A disqualified person or entity cannot be hired by the IRA to manage the property.

Example: IRA Holder says, “Well, since I can’t personally manage the property for a fee, can the IRA pay a property management company that I own and manage myself?”

Facts: The short explanation here is that your IRA cannot employ an entity that is managed or controlled by you or your direct lineal ascendants or descendants. The IRS logic here is to keep all IRA transactions completely arms-length and not co-mingled with any personal benefit. To truly understand this rule, you need to continue reading more about “Disqualified Persons” under Section 4975 of the Internal Revenue Code.

4. You cannot take a personal commission as a real estate professional for brokering your IRA’s real estate transaction.

Example: As a real estate agent by profession, you’d like to help yourself by brokering the transaction and taking the commission for the deal.

Facts: As mentioned above, IRA transactions need to be made as arms-length investments, separate from any personal benefit. You are not permitted to immediately benefit from your IRA investments; rather, you are investing for the future. You can negotiate a change in the purchase price of the property that may reflect your services, but you may not take a commission personally.

How to partner with your IRA to buy Real Estate

Q - It is possible, supposedly, to "partner with your IRA". You put in, say, half the money and the IRA puts in the other half. The partnership does a fix and flip. The net profits would then be split 50/50.
Is this true? I thought you could only do this if you start the business with the IRA as a partner. But if your business already exists, you cannot use funds from your IRA for a flip. Is that not right?

U.S. Department of Labor ruling 2000-10 allows you to partner with your IRA but there are special circumstances under which it is allowed. Otherwise it's self-dealing and a prohibited transaction. Here are the basics for partnering with your IRA.

Your IRA can partner with another person, entity or IRA. In partnering, as you may know, the IRA would own only a percentage of the property and the remaining portion would be owned by someone else. You may partner your IRA with personal funds and/or disqualified persons, but some restrictions apply.

One major restriction is when your IRA partners with disqualified persons, the ownership percentage must be kept constant throughout the life of the investment, and all expenses and income must be split according to that ratio. Each bill must be paid according to the ownership ratio. 

For instance, if you and your IRA each pay half of the cost for a real estate investment, any renovation or fix-up costs must also be split in half. Conversely, any income from the property must also be split in half.

Although these restrictions require an active investor to properly manage the investment, a good self-directed IRA provider can smooth the edges and make your investment and management process easier. Partnering with your IRA has worked for some of our clients and can be a valuable tool to increase retirement funds and acquire lucrative real estate assets.

And, contrary to popular belief, you don’t need to start an LLC when partnering with your IRA to purchase real estate. You can also partner with non-disqualified persons to your IRA such as your siblings or cousins to set up a more flexible investment plan.

5 little known facts about Real Estate IRA investing

1. An IRA can secure a loan in order purchase an asset. If you have a property in mind but don’t have the funds in your account to purchase it outright, the IRA may be able to secure a non-recourse loan. Keep in mind that not all lenders make this type of loan, and, because the lender cannot rely on personal assets as collateral, it is common for them to require a down payment of 30% to 40%. Also, an asset secured using a loan may be subject to Unrelated Business Income Tax (UBIT). This may sound like a negative, but needing to pay UBIT means that the investment is making money.

2. Real Estate has always been an allowable asset in an IRA. This fact, however, is not widely known. In fact, the IRS received so many inquiries, IRS.gov issued this statement, “…IRA law does not prohibit investing in real estate, but trustees are not required to offer real estate as an option.” Because IRA providers are not required to offer real estate, it is up to the IRA holder to establish an account with a provider that will perform the administration and bookkeeping necessary for that asset.

3. While an IRA holder can provide brain power for his/her Self-Directed IRA, he/she is not allowed to perform physical services for the real estate assets the IRA owns. It is relatively well known that an IRA holder can’t live in real estate that his/her IRA owns, it is less well known that sweat equity is not allowed. Many people would like to be able to have their IRA purchase a rental property and then act as the property manager, including making repairs and performing maintenance. Unfortunately, the IRA holder can only contribute some brain power/strategy to the operation of an IRA-held property. When the IRA holder goes over to the property to paint a room, do some light plumbing, or some other physical service, he/she is stepping into a prohibited activity.

4. An IRA can partner with other investors, with other IRAs, or even with the IRA holder’s personal funds to purchase an asset. In this scenario, the IRA purchases a percentage of the asset and the partners purchase the balance. It is important to note that all income and expenses need to be divided along the percentage of ownership lines. For example, if in a partnership, the IRA buys 50% of an apartment building, then 50% of all of the income and expenses come to and are disbursed from the IRA. So, if your IRA does not have enough money to purchase 100% of a real estate asset, and you don’t want your IRA to secure a loan, it may be a good idea to think about using a partnership to acquire the asset you want.

5. A real estate asset held in a traditional IRA does not have to be sold in order to be distributed to the IRA holder. While it is certainly allowable for an IRA to sell a property and then distribute the proceeds, there is another alternative. The physical asset itself can be distributed, with the obligatory tax on its value. In addition to a complete distribution of the asset, a percentage of a property can be distributed in a given year. The way that works is that the real estate is re-titled to reflect a new percentage of ownership between the IRA and the IRA holder. The IRA holder would then pay the taxes on the value of the percentage distributed in that year. In this manner, the tax burden could be spread out over a period of years while still holding on to the physical property.

Real Estate IRA: How the IRS treats Prohibited Transactions

When it comes to owning real estate assets in an IRA, it may be tempting to live in the property or work on the property before it is distributed out of the IRA. However, these are prohibited by the IRS and can result in steep penalties and a distribution of the account.

At New Direction IRA, we hear a lot of questions from investors asking what they can and can’t do with their IRA property according to IRS rules. Here’s a few of those questions and some basics about how the IRS treats prohibited transactions within real estate IRAs.

The Basics

IRS audits are extremely thorough. If you break a rule and your IRA is audited, you’re affairs better be in order. The penalties can be extremely damaging to an IRA. On top of that, unlike within our Judicial System, the accused is guilty until proven innocent – not the other way around. The burden of proving innocence falls on the accused taxpayer.

The IRA prohibited transaction rules can be found section 4975 of the IRS code. In respect to buying real estate within an IRA, you (and your direct lineal relatives) cannot use the asset that your IRA owns. Additionally, your IRA cannot have transactions (buy/sell) with you or your direct lineal relatives. If your IRA owns a property, there is no way for you to use the property or benefit from the property in any capacity. 

Likewise, if you own an asset personally there is no way to move it into your tax-deferred IRA.

“How would the IRS know if I use the property?”

SDIRA administrators and providers can help account holders avoid prohibited transactions, but their purpose isn’t to babysit investors and make sure they follow the rules. If your IRA owns real estate and you haven’t distributed that real estate, you cannot live in or physically work on that property. It is prohibited to do so and could result in the distribution of that asset.

The IRS is not likely to monitor an IRA holder’s investments, so the agency relies on administrators to report prohibited transactions. At New Direction IRA, we won’t process a prohibited transaction and illegal distributions are reported to the IRS so they can be properly taxed and penalized. And, if your IRA is audited, the IRS may be able to determine if you lived in or worked on the property.

“What if I sell my personally owned property to my friend and then buy it back with my IRA? How would the IRS ever know?”

Buying the property with your IRA from your friend is not directly a prohibited transaction; however, the arrangement of selling something you own to the friend and then buying back with the IRA is most definitely a prohibited transaction.

The IRS doesn’t just look at transactions on paper, they also look at the circumstances involved. The IRS has seen just about anything an investor could propose or scheme. They can recognize these prohibited structures and declare them as a prohibited transactions.

Other investors suggest using an LLC to get around the IRS rules. LLCs can sometimes be useful in structuring real estate investment. However, they are not magical entities that make all the rules disappear. If your IRA invests in an LLC, then the rules apply to the IRA now apply to the LLC as well, but now the onus is on you to maintain proper bookkeeping for the account in case of an audit.

Penalties

The penalties for prohibited transactions can be extremely harsh. Each case is judged on a case by case basis. An IRA that committed a prohibited transaction will almost certainly lose its tax-deferred status (the IRA would be immediately distributed to the account holder). This can create an unexpected tax liability as well as penalties if the account holder is under the age of 59.5. On top of that, the IRS will most likely impose a 15% prohibited transaction penalty. There have been extreme cases when the prohibited transaction resulted in 100% loss of the IRA. Prohibited transactions are not to be taken lightly.

The bottom line: your IRA receives special tax treatment from the IRS. IRAs have built in tax-deferred growth. In order to maintain that treatment, it is important that the IRA investments are just that--investments. If you want to use the IRA funds or benefit from the IRA funds then you should take a distribution, pay the tax and then do whatever you like with the funds. However, while they remain in the IRA you (and your direct lineal family members) should not benefit from what the IRA is doing.

Step-up in basis of Real Estate IRA assets

Question: If I die before the sale of my investment property, will my heir be able to benefit from step-up in basis and pay fewer taxes?

Step up in basis at death is not available for a Traditional IRA’s assets, including any real estate it owns.  Normally, if you die before the sale of investment property, your heirs would get a step-up in basis, meaning they could sell it immediately and pay no tax. If it is in an IRA, there is no step-up in basis and they would pay taxes on the amounts distributed from the IRA at their ordinary tax rate.

However, the goal for any retirement plan is to maximize its value.  If real estate assets achieve a higher return than any other investment available, then that should be the investment of choice.  

Alternatively, this issue can be solved by converting the Traditional IRA to a Roth IRA.

Step up basis is not a concern for Roth IRA owners who invest their IRA in Real Estate because their taxes will have already been paid, either in the year of contribution to the Roth or at the time of conversion from Traditional to Roth. Plus, those benefits pass to the beneficiaries of the account.

The recent relaxation of Roth conversion rules has led to a surge of account holders electing to pre-pay their future income retirement income tax by converting from Traditional to Roth IRAs. This legislation is beneficial to investors who believe they will pay fewer taxes by converting their IRA now than they will upon distributing their Traditional IRAs at retirement age.

Like all investments, due diligence is required to decide what will work best for your IRA and its investments. New Direction IRA can help with the administration and bookkeeping of your IRA, and will ensure your transactions and/or conversions are done according to IRS code.

Browse our website for more answers to the most common questions and concerns about self-directed IRAs. New Direction IRA is committed to providing you with the best education so you can self-direct your IRA successfully.

Real Estate IRA Valuation

Question: Do I have to get my IRA-owned real estate appraised every year and how much will that cost?

If you own real estate property, you have to submit a valuation to your administrator every year to ensure proper tax reporting by your IRA administrator. A fair market valuation is used to establish or change the value of a real estate holding.  All IRA custodians are required to provide a year-end value for IRA accounts. A qualified real estate professional who is not a disqualified person to your IRA may provide a comparative market analysis to meet this requirement. 

When you reach retirement age, the IRS requires you to start taking Required Minimum Distributions (RMDs) from your IRA. The RMD amount is based on the value of your IRA assets as of Dec. 31 of the previous year.

Formal appraisals for the annual valuation are generally expensive and they aren’t required, though they are acceptable. You can instead get a valuation which is usually much cheaper, and sometimes free.  Although an appraisal is a valuation, they are not one and the same. We understand that real estate agents may not provide appraisals, but they are qualified to determine the market value of a property.

Like all investments, due diligence is required to decide what will work best for your IRA and its investments. New Direction IRA can help with the administration and bookkeeping of your IRA, and will ensure your transactions and/or conversions are done according to IRS code.

Browse our website for more answers to the most common questions and concerns about self-directed IRAs. New Direction IRA is committed to providing you with the best education so you can self-direct your IRA successfully.

Real Estate IRA Tax Rates

Question: When you receive an IRA distribution of cash that was made from the sale of real estate, it is taxed at ordinary income tax rates. Isn’t this rate much higher than the capital gains rate you would pay on the sale of real estate outside of the IRA?

Yes, Traditional IRAs give you a tax deduction for contributions and you pay taxes on distributions. Both are at ordinary income rates which are higher than capital gains rates. This is true for any IRA asset, not just real estate.  Even if your IRA invested in securities like stocks and mutual funds instead of real estate, distributions of any gains will be taxed ordinary income tax rates.

If your goal is to minimize taxes at distribution you may wish to convert your existing Traditional IRA to a Roth IRA.  Distributions from Roth IRAs are generally tax-free.  Conversion may be done at any time; income tax at ordinary income will be due on the converted amount. Many investors feel the Roth IRA is a much better long term plan as the taxes are effectively prepaid on the money.  Both contributions and the income and profits are withdrawn tax free.

Recently, much of the appeal of real estate investing is the positive cash flow it can generate. For IRAs owning real estate, generating income can make it an attractive option even without the potential for appreciation. The tax your IRA may incur at the end of an investment is only one factor to consider. Smart investors can generate significant revenue from rent. Cap rates of 4 to 10% are not uncommon and, when compared to returns from other assets, can be very enticing for investors in today’s economy.

In many cases, income generated from real estate assets can cover any Required Minimum Distributions (RMDs) required for Traditional IRAs at age 70 ½ .

Remember, the point of owning real estate or any asset in an IRA is to increase the total value of your IRA.

Like all investments, due diligence is required to decide what will work best for your IRA and its investments. New Direction IRA can help with the administration and bookkeeping of your IRA, and will ensure your transactions and/or conversions are done according to IRS code.

Browse our website for more answers to the most common questions and concerns about self-directed IRAs. New Direction IRA is committed to providing you with the best education so you can self-direct your IRA successfully.

Can I live in my Real Estate IRA property?

Question: Is it true I can’t live in or vacation in my IRA-owned real estate?

Benefiting personally from any asset owned by your IRA is prohibited by the IRS. It’s called self-dealing. Furthermore, you can’t let any of your lineal relatives benefit from the asset either; this includes your parents, grandparents, children, grandchildren, spouse and fiduciaries. None of you can live in or lease or vacation in real estate owned by your IRA.

Additionally, you can’t put any personal funds or sweat-equity into the property. New Direction spends the majority of its educational efforts on the rules regarding self-dealing.  Unlike having your IRA own shares of IBM or some other security, the temptation and ability to influence a real estate asset is very real.  Using personal funds or time (“sweat equity”) to benefit the property is strictly prohibited.

Think of it this way: Your IRA is taking advantage of IRS rules that allow it to grow tax-free or tax-deferred. The assets that you purchase with your IRA are not yours, and shouldn’t be viewed as such. We tell our clients that they should think of the IRA as a separate entity (we call it Uncle IRA to illustrate this separation). 

The client’s job is to make good decisions related to the investment, but not have transactions with Uncle IRA or his assets.  These rules are the same for any asset owned by the IRA, but like we mentioned, the temptation to influence real estate owned by your IRA is much greater than other assets. 

When it comes time to distribute the asset, you can certainly take it out of your IRA and live in it then.  It becomes your personal property after distribution. Smart investors will have maximized the investment before then, however, by renting it to tenants or buying property that has increased in value over the years.

Like all investments, due diligence is required to decide what will work best for your IRA and its investments. New Direction IRA can help with the administration and bookkeeping of your IRA, and will ensure your transactions and/or conversions are done according to IRS code.

Browse our website for more answers to the most common questions and concerns we receive. New Direction IRA is committed to providing you with the best education so you can self-direct your IRA successfully.