Your IRA Can Invest in Real Estate

Thursday, January 14, 2016

Your IRA Can Invest in Real Estate

Recently, a few of our clients expressed interest in having their Individual Retirement Accounts invested in residential and commercial real estate and questioned whether this is allowed. They sought this advice out of a desire to further diversify their IRA portfolio and take advantage of depressed values of real estate.

IRA’s may hold almost any investment other than “collectibles” (e.g., antiques and stamps). Therefore, it may invest in real estate. However, the IRA account holder can not serve as the custodian of his or her own IRA account and a majority of IRA accounts have banks and brokerage firms as custodians. These institutions generally limit the investments to stocks, bonds, mutual funds, annuities and similar financial investments. Since they generally do not permit the IRA to invest in real estate, an IRA owner who wants to do that has to find an independent IRA custodian that allows real estate investments. This can be accomplished by establishing a self-directed IRA.

A self-directed IRA allows the account holder to make investment decisions on behalf of the retirement plan. However, IRS regulations require that the assets be held by a qualified trustee or custodian. There are a number of IRA custodian firms that will fulfill this role. They provide record keeping and administrative services and file required IRS information returns. When choosing the custodian, it is important to make sure that the custodian understands the rules and regulations of IRAs, especially those pertaining to prohibited transactions. Fees charged by the custodian for these services vary depending on the services provided.

Some of the rules related to the ownership of real estate by an IRA include:

  • The IRA can not purchase property from the owner of the IRA, certain relatives of the IRA owner or the custodian of the IRA
  • Real estate purchased by the IRA may not be used by the IRA owner or certain related parties for any purpose
  • There may be tax consequences if the IRA operates a real estate business
  • A mortgage in an IRA can not be personally guaranteed. Therefore, a mortgage for the purchase of the property must be non-recourse which will make it difficult to purchase property unless cash is available for the full purchase price.
  • The property may not be sold to the IRA owner or certain related parties.
  • Expenses of owning the property, such as real estate taxes, must be paid by the IRA. Liquid funds must be available to pay these expenses.
  • After the owner of the IRA reaches age 59 ½ the real estate can be distributed to the owner of the IRA without penalties.. If the IRA is a traditional one (not a ROTH) the owner will have to pay income tax on the then fair-market-value of the property.

We generally advise our clients to engage investment advisors and financial planners to help them construct an investment portfolio that is appropriate for their retirement plan. It is even more important to do this if you are considering the purchase of real estate for your retirement investment portfolio. Real estate remains a risky investment in an asset that is illiquid, requires the use of other funds in the retirement account for expenses and may not be sellable when funds are needed for retirement.

On the other hand, real estate can provide diversification, positive cash flow and capital gains. Furthermore, it can help fulfill other goals for retirement. For example, one of our clients had his IRA purchase residential real estate in Maine where he plans to retire in a few years. As a result of careful planning and sound investing over several years, the IRA was in a position to purchase the property for cash and had enough cash to pay real estate taxes for several years in the event that rental income is unable to cover them. The property is rented and currently generates cash flow that exceeds the operating expenses. The plan is to have the property distributed to the owner when he retires to be used as his residence. He is aware of the need to have cash at that time to pay the income tax on the value of the distributed property since it is a traditional IRA.

Once the risks and rewards of real estate ownership by an IRA are understood, the IRA owner can consider whether it is appropriate to have real property purchased through a self-directed IRA.

Bruce S. Baron, CPA

6433 South Killarney Court
Centennial, CO 80016
Tel: 303.823.4664
Mobile: 732.685.5399