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.

Living in your IRA-owned real estate

“I have an IRA invested in Real Estate. Now how do I take that real estate to live in, when I’m retired?”

Hopefully, that rental property has served your retirement plan well, not only appreciating in value over time, but also providing regular monthly cash flows over a number of years.

But what if you’ve decided you really want to retire and live in that house?

If the house was purchased by your Roth IRA, and you’ve held the Roth IRA for 5 years and turned 59 ½, it’s yours to distribute to yourself, with no tax or penalties.

But what are your options if your real estate assets were held in a Traditional account?

Certainly, you can distribute the house once you’re 59 ½, without paying any premature withdrawal penalties. But you’ll have to pay taxes on the dollar amount (in this case, property value) of your withdrawal, as though that amount was some cash added to your income in the year you take it. Naturally, since we’re talking about thousands of dollars, this may be costly. However, you have a few options:

1) You can distribute your IRA’s holdings a little bit at a time.

For example, at age 59 ½, you could begin distributing 10% of the property from your IRA each year. If you distributed 10% in year one of such a program, this would result in the property being owned 90% by your IRA and now 10% share is owned by you. You’ll need to arrange with the title company so that the ownership share is properly reflected accordingly each year. You’ll still be constrained from using the property personally until it is entirely distributed from the IRA. This will allow you to spread the tax burden from distributions over a 10-year period.

Keep in mind, this will change your monthly cash flows. You will personally be entitled to a direct 10% of income and responsible for 10% of expenses. These proportions would need to be honored since there are now two investors: you and your IRA.

2) You could consider converting a portion of your IRA (including that real estate asset) to a Roth IRA.

Yes, you’ll pay income tax on the amount you convert, but this may make sense for you, if you anticipate a number of years more of income to sock away, and for your IRA’s value to grow, before reaching age 59 ½. The point here is you may be paying some tax now on a smaller amount, instead of paying tax on a potentially larger amount down the road at retirement.

You could also convert a fractional share from your IRA to a Roth IRA each year so that at some point in the future your Roth IRA owns the entire property. Then, if you’ve reached age 59 ½ with 5 years in that Roth IRA, it’s available to withdraw free from penalty or tax.

3) You may elect to begin distributing shares of your property before retirement age by using the 72T method.

The IRS grants the 72T method (substantially equal payments) as an exception, which enables one to avoid the penalty for early IRA withdrawals.

The 72T exception offers a choice of methods, which you can use to tailor the timeline of your distributions. All are based on your life expectancy (or, if you elect, on the joint life expectancy of you and your beneficiary), and whichever method you choose must be continued for at least 5 years or until reaching age 59 1/2.

Best practices for Real Estate IRA investing

How to manage your Real Estate IRA Investments

For those with a penchant for real estate investing, IRAs are a potent vehicle indeed. Outside of a tax-advantaged account, such as an IRA or a SEP IRA, rental income is taxable every year, as you receive it, and passive activity rules restrict your ability to claim losses from real estate. If you use a self-directed IRA, or a real estate IRA, however, you can accumulate all that rental income tax-deferred, or tax-free if you hold the asset in a Roth IRA. If you have the patience, liquidity and know-how to be a successful real estate investor, it can make perfect sense to leverage these skills in a self-directed IRA or other retirement account as well.

That said, there are some things that you need to be aware of that are unique to using an IRA or other retirement account for real estate investing, because if you don’t comply with certain rules and regulations, you risk exposing yourself to unintended penalties and taxes.

Watch Your Cash Flows

Paying attention to cash flow is critical with real estate IRA investing. Remember, the law limits the amount of new money you can contribute to an IRA each year to $5,000 (or $6,000 if you are over age 50.) As any veteran property owner knows, property repairs and renovations can easily exceed many times this amount.

This means you can’t intervene in your IRA-owned property with a massive cash infusion from outside your retirement accounts, no matter how badly your property needs the repairs. For anything over the max $5,000 annual contribution, you will need to pay for it from liquidity you have in the IRA itself, roll the money over from another eligible retirement account, or have your IRA borrow the money.

For this reason, it’s generally best to have some liquid reserves – cash, cash equivalents, reasonably stable securities, or a line of credit your IRA can tap for this purpose. Your checking account won’t do you much good when you have to pay for a $30,000 roof.

Set Aside Cash in Your IRA

Outside of an IRA, the tax code provides a natural means for investment property owners to set aside some reserves. This is part of the logic of depreciation deductions – you’re supposed to set aside the savings to pay for expected repairs, maintenance, upkeep and eventual replacement. But you don’t get a depreciation deduction in an IRA. You need to set aside reserves from operating income within your IRA or be prepared to transfer assets from elsewhere.

Understand Prohibited Transactions

Remember, you can’t lend money to your IRA personally. If your IRA needs to raise cash in a hurry, you can’t be the person to provide it, beyond allowable contributions and rollovers. The same applies to your descendants, your parents and grandparents, and any of their spouses. Ditto for any business entities they control. (The law does not specifically rule out your brothers and sisters, though).

The same people who can’t lend to your IRA also can’t borrow from it, for the same reason (though you can use your self-directed IRA to lend money at interest to whomever else you like.)

Likewise, you can’t do business directly with your IRA, nor can any other disqualified individuals, nor can their spouses or any business entities they control. Some people try to open a property management company, or construction company, and have their IRAs compensate their companies directly for services rendered. This is prohibited by the IRS.

Understand Long-Term Tax Ramifications

If you hold a real estate investment outside a retirement account, and sell it at a profit, you pay tax at capital gain rates. If you held it for more than a year, your capital gain tax will be less than your income tax. However, if you hold the property in a tax-deferred retirement account, you will need to eventually pay income taxes on any gains, rather than the lower long-term capital gains rate. To avoid this, consider using a Roth IRA to hold real estate or capital assets in an IRA. You don’t get a current year tax deduction, and you can’t take depreciation deductions in either case. But any gains are tax free. Additionally, you sidestep the eventual problem of taking required minimum distributions when you get older, which can be a challenge if your retirement portfolio is in illiquid holdings such as real estate.

Don’t Stay in the Property

Ordinarily, rental properties allow you to spend a couple of weeks per year in them without jeopardizing their status as investment properties. This is not true for IRA-owned real estate. You can’t live in the property, even if you’re paying rent. You can’t even stay overnight in the property. What’s more, you can’t let your children, grandchildren, parents, grandparents, or their spouses stay overnight either. If you do, the IRS could consider it a distribution, and impose a tax equal to 100 percent of the amount involved.

Be Careful With Borrowing

Many people are confused by IRS prohibitions on lending to or borrowing from your IRA personally, or pledging your IRA as collateral for a loan, and think that you cannot borrow money for your IRA at all. In fact, your IRA can borrow money. But understand that it’s your IRA that’s borrowing the money – not you. This distinction is crucial. Your IRA can only borrow money from non-disqualified individuals and entities on a non-recourse basis. This means that if the loan should default, the lender can only come after the IRA to collect. Only assets held within the IRA can serve as collateral for the loan. You cannot pledge anything outside the IRA as collateral, nor sign a personal guarantee of any kind.

Beware of Taxes

Taxes? In an IRA? Alas, yes. While your IRA can defer income tax and is generally exempt from capital gains tax, you still have to pay property taxes if you own real estate in your IRA. Additionally, if your IRA employs leverage – as is common for real estate investing – your IRA may be subject to unrelated debt income tax, or unrelated business income tax, depending on the situation. New Directions IRA does not give tax advice, so you should retain the services of a qualified tax advisor, such as a CPA, tax attorney or enrolled agent, for advice specific to your situation.

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.

How to manage a Real Estate IRA

Question: How do I manage expenses and cash flow in an IRA, particularly when I reach retirement age and have to take Required Minimum Distributions (RMDs)?

Planning for investment cash flow needs is critical for any investment strategy, particularly illiquid assets like real estate. Annual contribution limits vary from over $50,000 with 401k and SEP-IRA plans down to $3,150 for Health Savings Accounts (all of these plans may be self-directed and are available at New Direction IRA.) The investor needs to determine how much cash will be needed and how much will be available.

When you reach retirement age, you need to take RMDs. This is sometimes tricky for people who only have real estate in their IRA—they’re faced with the prospect of distributing a massive asset, which may incur a lot of tax, to meet the RMD requirements.

Many of our clients choose to own more liquid assets in addition to real estate, such as cash, securities or other alternative assets. Clients also sometimes set up a reserve for unexpected expenses. This allows them to be more flexible, particularly when it comes time to distribute their assets yearly. It is also possible to take incremental “in-kind” distributions of the property itself to satisfy the RMD requirement. This is done by re-titling the real estate each year showing an increasing personal ownership. Although this option may seem complicated it is done.

In addition, real estate is unique in that it can generate cash flow for your IRA. By renting the property to tenants, some clients can generate enough income to offset their RMD requirements.  

Don’t forget that RMDs apply to Traditional IRAs and regardless of what type of asset you hold, it’s only smart to have a plan for how to accommodate these distribution requirements.

If you come across a situation where your IRA cannot afford any incurred expenses, then you should make plans to sell it, bring in other investors, liquidate other assets or make contributions. It is important that you only use IRA funds for all expenses associated with the property including taxes, repairs and insurance. You are not allowed to use personal funds to cover these costs; if you do, your IRA may be disqualified by the IRS.

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. NewDirection IRA is committed to providing you with the best education so you can self-direct your IRA successfully.