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IRA Investment in Real Estate

The purpose of IRAs is to provide for retirement.  Putting your money and/or property into a "self-directed" IRA can be a good idea to grow long-term, tax-deferred or tax-free assets.  A self-directed IRA is an IRA that allows the account owner to make investment decisions and investments on behalf of the IRA.  Your IRA can make investments in a wide range of assets including: real estate, oil-gas-energy, private stock offerings, private placements, and more. You should bear in mind, however, that property owned by an IRA will not receive a step-up in basis upon your death as it would if the property was owned personally by you. 

With the recent rise in property prices, you might ponder whether to invest your IRA funds in real estate to defer/decrease taxes and earn a good rate of return.  When you invest in real estate outside of a retirement plan, you will owe tax on your rental income (rental revenue less expenses).  Without an IRA you will also owe taxes, if you later sell the property for a gain.

You, however, won't pay taxes on your IRA investment/rental revenue while it is within your IRA.  But you will pay ordinary income tax--which is higher than capital gains rates--on money received from an IRA.  Therefore, the gain on the sale of property by an IRA may be taxed on the ordinary income tax rate on the distribution of the money to the individual IRA owner. An IRA delays taxes on your real estate income as long as you keep the money in the IRA. On the other side, losses can't be claimed when held by an IRA. Rental property can provide a steady stream of rental income that can be sued to pay off mortgages and other expenses on your investment property.  Extra rental income can stay in your IRA, where it will grow tax-deferred, and can be used for future investments.  Bear in mind, that you generally must start taking withdrawals from your IRA when you reach age 70 1/2.

If you invest in real estate through a Roth IRA, your investment earnings are tax-free when you take a withdrawal after age 59 1/2.  By investing in real estate with a Roth IRA, you will not have to pay taxes on your rental income, your capital appreciation, or your gains from selling the property.  You, however, will not get a tax deduction for your contributions into the Roth IRA, like you do with a traditional IRA.  The Roth IRA may be a better choice with a large real estate investment, since the gains in traditional IRA are taxable when you begin to withdraw money during your retirement year.

To invest in property, the IRA must buy property without any of your own money.  In order to do this, you would open an IRA custodial account, transfer cash from an existing IRA account or an 401(k) account into the IRA custodial account and then purchase real estate under the IRA account name.  

An investor should get advice on the rules that govern what can and cannot be done when funding, buying and managing the property within your IRA.  For instance, you will likely need to have enough cash in your IRA to purchase the properties, as a mortgage may not be obtainable.  A mortgage will have to be in the name of your IRA and not in your individual name. The mortgage must also be a non-recourse loan--only secured by the value of the real estate. It is possible to buy and sell real estate within an IRA (flipping properties), but there are limits on how many of these buy and sell transactions can be done per year.  

An IRA is allowed to invest in real estate; however, you can't have your self-directed IRA buy property from or sell property to yourself or any disqualified person.  A disqualified person includes: a) family members (e.g., spouses, parents, children, etc.); b) IRA service providers; and c) companies in which you or fiduciaries own 50% or more; and d) fiduciaries (includes yourself). The IRS considers transactions between an IRA and disqualified persons as prohibited self-dealing. The IRS takes a dim look on actions that provide a current benefit to you or disqualified persons as opposed to providing for retirement. 

You cannot have indirect benefits from property owned by your self-directed IRA. Given the purpose of IRAs, buying a vacation home for use now is an indirect benefit that is not allowed. Likewise, buying an office building to use as your personal office space would provide an indirect benefit.  A few indirect benefits that are not allowed by an IRA that has purchased real estate, include the following:  a) personally using property as office, vacation home, personal residence; b) paying yourself to do work on a home purchased by your IRA.

Real Estate purchased by the IRA must be titled in the name of the IRA only and not yourself.   A title example of real estate owned by an IRA is as follows: "Equity Trust Company Custodian [for benefit of](FBO)[Your Name] IRA".   However, you can purchase property as an undivided interest and in partnership with others.  All expenses related to property owned by a self-directed IRA must be paid by the IRA.  Property expenses include: property taxes, maintenance, repairs, improvements, landscaping, cleaning, condo fees, etc.  Likewise, all income generated by property owned by a self-directed IRA must go back into such IRA and remain to avoid taxation.  When you have to receive your Required Minimum Distribution (RMD), it can be done through undivided interests in the property over the calculated term of your RMD based on the fair market value of the property (determined on an annual basis).

Bowman Law Firm,

Gene M. Bowman, Attorney