If you want to diversify your retirement portfolio and invest in alternative assets, you may wonder if you can use your individual retirement account (IRA) to buy real estate. Traditional financial assets like exchange-traded funds (ETFs), stocks, mutual funds and bonds can all be great investment options. However, diversifying your portfolio can yield greater returns and provide a safety net.
Unfortunately, many Americans are unaware that it’s possible to use your IRA to invest in alternative assets, such as private equity, precious metals and even cryptocurrency. At Accuplan, we want to give you the information you need to make the most of your investments and IRA.
Can You Use Your IRA to Buy Real Estate?
Yes, you can invest in real estate through your IRA by using a self-directed IRA. A self-directed IRA is a type of retirement account that provides more control over your investment choices and allows you to invest in assets beyond traditional options. You must follow certain rules when engaging in such transactions, such as purchasing the property for investment purposes only.
Buying real estate in an IRA typically involves cash transactions, and the IRA is responsible for covering all related expenses. As long as you follow the regulations and rules set by the Internal Revenue Service (IRS), you can choose to use your IRA to buy land and property.
Benefits of Investing in Real Estate With Your IRA
Using your self-directed IRA to buy real estate comes with several benefits. Here are some examples:
- Tangible assets: Tangible assets can be a great investment option because they are worth something even if the market dips.
- Tax benefits: When you invest in real estate with your self-directed IRA, the property gains the same tax benefits as an IRA.
- Diversification: You can diversify your portfolio by investing in different asset classes, potentially reducing risks.
- Potential for cash flow: Rental properties, for example, can generate consistent cash flow from rental payments.
- Control over investment: You can select and manage your preferred property type depending on your goals and risk tolerance.
What Types of Real Estate Can You Invest In?
Real estate is often considered a stable investment during uncertain times, as it can provide income to the owner and appreciate over time. With a self-directed IRA, you can invest in a variety of real estate assets, such as:
1. Residential Property
You can invest in residential properties like single-family rental homes. These properties can potentially generate high rental income and can appreciate. They are a common choice for investors looking to generate cash flow, especially in retirement. When choosing this option, remember that the IRA must hold the title to the property. Additionally, all income and expenses must flow through the IRA. Personal use of the property is prohibited.
2. Commercial Property
Commercial properties are those used for business purposes. Examples include office buildings, retail spaces and warehouses. Commercial properties often yield higher retail income compared to residential properties. Also, leases could be longer-term. However, they require more capital and management. As with residential properties, income and expenses must go through the IRA.
3. Real Estate Investment Trusts (REITs)
REITs own, operate or finance real estate that produces income. They can be publicly traded or private. REITs allow you to invest in real estate without direct ownership of properties. This arrangement typically offers liquidity and diversification. REITs may be subject to different tax implications and may not provide the same level of control as direct real estate investments.
4. Unimproved and Improved Land
Unimproved lands are raw lands. Improved lands have essential utilities like water, electricity and sewage but no buildings. These properties can appreciate in value, especially in growing areas. Between the two, improved lands often generate higher rental income.
Note that zoning and development regulations can affect the investment. Furthermore, unimproved lands may require holding costs without immediate returns.
5. Mortgage Notes
This option involves investing in notes that secure loans on real estate properties. When the borrower defaults, the lender can foreclose on the property to cover the debt. Mortgage notes can provide regular income through interest payments. Before investing, it’s vital to understand the mortgage market and potential risks associated with borrower defaults.
6. Joint Ventures
You can partner with other investors or companies to invest in real estate projects. The advantage is that pooling resources can reduce individual risk and increase investment potential. Investors who choose this option must comply with the IRS rules regarding joint ventures and prohibited transactions.
7. Tax Lien Certificates
When a property owner fails to pay taxes, the IRS or state tax agency can impose a lien on that property and issue a tax lien certificate. You can purchase that certificate, earning interest on the amount paid for the lien. Your IRA may acquire the property if the owner does not pay.
This investment type requires knowledge of the local laws and processes. Also, there can be risks when the property owner redeems their liens.
8. Limited Partnerships
You can invest in limited partnerships that focus on real estate investments. This arrangement allows you to participate in larger real estate projects without directly managing the property. However, you must ensure the partnership structure complies with the IRS regulations for self-directed IRAs.
9. Trust Deeds
This option allows you to invest in the security interest of a property through a deed of trust. You can earn interest income secured by real estate. Understanding the legal implications and risks associated with trust deeds is crucial when choosing this investment type.
How to Use Your IRA to Invest in Real Estate
Now that you know the benefits and types of real estate, you must learn how to invest with your self-directed IRA. The following steps will guide you:
1. Find a Custodian
A custodian is a financial institution or specialized company that holds and administers self-directed IRAs. They help investors manage transactions, financial reporting and related paperwork and ensure compliance with IRS regulations. An example is Accuplan Benefits Services.
2. Get a Self-Directed IRA
Open a self-directed account with the custodian. Typically, you must fill out an application and provide identification and other documents. Decide the type of account you want because each has a unique tax benefit.
3. Seek Expert Advice
It’s wise to consult a professional before investing. They can help you understand the benefits, risks and strategies. Professionals can also perform due diligence to reduce risks.
4. Learn the Rules and Restrictions
Familiarize yourself with IRS rules regarding self-directed IRAs. This step is crucial to avoid sanctions and other inconveniences. You can always go back to the expert to seek clarification. The goal is to make informed decisions.
5. Fund Your Account
You can fund your self-directed IRA through contributions, rollovers from other retirement accounts or transfers. Remember that rolling over or transferring your funds could take some time. Again, adhere to annual contribution limits and IRS rules regarding rollovers.
6. Find a Property
Identify potential real estate investments based on your investment strategy. For example, determine the type of residential and commercial property you prefer. Conducting market analysis, property evaluations and due diligence to assess potential properties is crucial. After that, you can make an offer. Ensure the purchase agreement clearly states that the buyer is the IRA, not you personally.
7. Manage Your Investment
Once you acquire the property, you must manage it according to the IRS rules. For example, all income and expenses must pass through the IRA. Also, the property must be continuously used for investment purposes only. Last, maintain thorough records of every transaction. As earlier mentioned, your custodian may assist with record-keeping and tax reporting.
Restrictions When Using Your IRA to Buy an Investment Property
There are a few restrictions you may want to keep in mind when using an IRA to purchase an investment property. These include:
- Self-directed IRAs: The account you use to invest in real estate must be a self-directed IRA. This account allows you to invest in alternative assets the custodian offers, so your custodian must provide your preferred property type.
- Disqualified persons: A disqualified person can’t conduct business with your IRA or benefit directly from the property. A disqualified person can be the account owner, beneficiary, spouse, descendants, custodian or an entity in which the account owner has at least 50% interest.
- Prohibited transactions: Prohibited transactions refer to the leasing, exchange or sale of a property between your IRA and a disqualified person or the transfer of IRA assets or income that benefits a disqualified person.
- Sweat equity: Improvements, upgrades and repairs are part of managing a rental property. However, you could face rules regarding sweat equity when your IRA is the property owner. Sweat equity prohibits you from working on any property owned by your IRA.
- UDFI and UBIT: Unrelated Debt-Financed Income Tax (UDFI) and Unrelated Business Income Tax (UBIT) can apply to your IRA’s assets. UDFIs relate to income from assets bought with borrowed funds. UBIT is typically triggered by earnings from business operations conducted within tax-exempt entities.
- Funding rules: You can fund the property in several ways. Examples include crowdfunding, purchasing with a non-recourse loan or directly purchasing the asset with a portion of your self-directed IRA funds. Funding rules may apply depending on which option you choose.
- Personal use of property: Legally, rental properties purchased through a self-directed IRA are exclusively owned by the IRA. You cannot use the property for personal use.
Tax Implications of Using a Self-Directed IRA to Buy Real Estate
As mentioned, investing in real estate with your self-directed IRA has many tax implications. It’s vital to dive deeper to build your understanding:
1. Tax-Deferred and Tax-Free Growth
Earnings can grow tax-deferred or tax-free depending on the type of self-directed IRA:
- Tax-deferred growth: Earnings from real estate investments within a traditional self-directed IRA grow tax-deferred until you withdraw them in retirement. Any income generated from the real estate, such as rental income and any capital gains from the sale of the property, are not taxed until you take distributions from the account.
- Tax-free growth: If you use a Roth self-directed IRA, qualified distributions in retirement are tax-free. This arrangement allows you to benefit from tax-free growth throughout the investment period, provided you meet the conditions for qualified distributions. For instance, the account must be held for at least five years, and the account holder must be at least 59½ years old.
2. UBIT
UBIT is a tax imposed on income generated from a business activity unrelated to an IRA’s primary purpose, which is to provide retirement income. This tax applies when an IRA invests in certain assets that generate revenue through business activities rather than passive income.
For example, if your self-directed IRA takes out a non-recourse loan to buy real estate, the income may be subject to UBIT. Also, if your self-directed IRA invests in real estate actively managed as a business, like a hotel or short-term rental operation, the income could be subject to UBIT.
Investments subject to UBIT must report the income to the IRS and pay associated taxes. This tax is paid from the IRA and does not affect your personal tax return as long as the income is generated within the IRA.
Real Estate Investment Strategies
Investing in real estate through your self-directed IRA requires planning and strategizing to maximize returns and reduce risks. Below are three key considerations:
- Long-term rental income: Investing in properties that yield returns over an extended period can provide steady cash flow. These assets can also increase in value. Yet, it is crucial to consider the management responsibilities and costs.
- Property flipping: This strategy involves purchasing properties at lower prices, making improvements or renovations, and then selling them at higher prices within a relatively short period. It can yield quick profits, but management can be complex.
- Assessment of investment risks: Regardless of the property you purchase, it is crucial to assess the risks. These include market volatility and liquidity concerns. You should also build an exit strategy.
Tips When Buying Real Estate Within a Self-Directed IRA
In addition to the strategies previously discussed, the following best practices are essential:
- Choose the right custodian: Custodians offer different services. It’s essential to look for one specializing in self-directed IRAs and real estate investments.
- Conduct thorough due diligence: Research the property before making a decision. In addition to the legal and financial considerations, conduct physical inspections to assess the property’s condition.
- Plan for tax implications: Learn the tax implications and use the rules to your advantage. Working with tax and real estate professionals to make informed decisions could be beneficial.
- Document everything: Keep detailed records of all transactions, communications and expenses related to the property. You may need them to demonstrate compliance.
Start Investing With Accuplan Benefits Services Today
Investing in real estate through your self-directed IRA allows you to diversify your portfolio. Depending on your investment strategy, you have many options. With the right platform, you can maximize returns without significant challenges. That is why choosing the right custodian is important.
Accuplan Benefits Services helps investors unlock exciting possibilities. We specialize in self-directed IRAs and have the resources to get you started. You can invest in a wide range of real estate properties. Contact us or sign up for an account today!
Disclaimer: This content is provided for informational and educational purposes only. It is not intended to provide, nor should it be depended upon for legal, investment, accounting or tax advice. We do not make guarantees regarding the applicability of the above information to your situation.
