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.

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 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.

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.

Depreciation of Real Estate IRA assets

Question: If I purchase property with non-IRA funds, I can write off depreciation but I can’t if I buy it with my IRA.  Why should I give up what appears to be such a significant tax advantage? 

This is probably the most common question we receive. Rather than giving up the depreciation tax advantage, you are trading it for a different and possibly better tax advantage.

Essentially, if you buy real estate with personal funds, you can expense a portion of the cost of the real estate over the allowed time period, usually 27.5 to 39 years.  Depreciation expense, which doesn’t require current cash (since you already invested the cash when you initially purchased the property) lowers your taxable income. 

IRA-purchased real estate is different and carries its own significant tax advantage. Money in a Traditional IRA has already been 100% deducted at the time of contribution, thus there is no basis left for an individual to deduct.  Money made in a Roth IRA, though not deducted when contributed, is tax free for the future. Either case is better than having to depreciate the property over 27 years or more.

The majority of our clients have money that is already in their 401k or IRA either from their personal contributions or their employer’s contributions. They are already enjoying the benefits of the tax-deferred or tax free money. The only way they could use those funds to purchase real estate personally would be to take it out of the plan, giving up its special tax status and in the case of Traditional IRAs, cause a current income tax.

Comparing post tax money in your pocket to pre-tax or tax-deferred money in your retirement plan is not comparing apples to apples. Since the tax advantaged money in the plan is, in effect, not yours until you take it out of the plan, the real goal is to grow the retirement fund as much as possible. How will you grow your IRA?

Some investors will search for property that is likely to appreciate in value. Our clients have invested their IRAs in land that they figured would grow in value in the future, while others bought property to rent out and generate a steady income.

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.

Is it expensive to have a Real Estate IRA?

Question: Is it expensive to have a real estate IRA? Won’t I have to pay a ton of custodial fees to manage a real estate IRA?

It’s not expensive to invest your IRA in real estate. At New Direction, we have a structured fee schedule so you’ll know exactly what you have to pay and when. These fees include a one-time startup fee and no fees until you make your first transaction.

Some people say that because brokers and banks generally only allow traditional investments in your IRA like stocks and bonds, that non-traditional investments somehow cost more money. But any account has costs. We encourage you to do your due diligence and check out fee schedules for securities-based IRA providers and compare that with how much money you can make with a smart non-traditional investment in real estate or precious metals. 

If you want to hold real estate with your IRA, you’ll have to find a provider like New Direction that specializes in holding real estate. There will be different costs than those charged by traditional IRA providers, but we’re confident our fees are competitive—and many times they are lower. In short, you don’t need to pay extra for the privilege to invest in non-traditional assets like real estate with 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 we receive. New Direction IRA is committed to providing you with the best education so you can self-direct your IRA successfully.