What’s a Real Estate IRA (And Is It Worth Having)?

Is a real estate IRA worthwhile? It’s a question worth exploring. While we cannot give you investment advice, we can introduce you to the nuts and bolts of a real estate IRA. Then you can decide whether to continue pursuing the idea.

Real estate is a solid asset. It can exist within an individual retirement account. And it can bring steady rental income into the account. Better still, income earned by the property stays within the IRA, so you won’t be taxed on it during that time.

Let’s look at the process from the beginning.

First Things First: Setting Up a Self-Directed IRA

To hold real estate using an IRA, an investor opens a self-directed IRA account. This takes a specialized broker to serve as custodian. Most popular brokerages won’t allow real estate into individual retirement accounts.  

The custodian will actively manage transactions involving the property. Your role will be limited, once you get the real estate into your account. This is because, legally speaking, you aren’t the property owner. A separate entity from yourself—your IRA—holds the deed. The property title will name the trust company (the custodian), “for benefit of” [your name’s] retirement account number.

This separation between you and whatever’s in your IRA can be a benefit. Your real estate asset has protection through its status as retirement account property. This is why some investors with multiple rental properties might put at least one into a self-directed IRA.

From now on, the custodian will manage deed transactions and agreements with third parties. The company will charge you fees for carrying out its administrative role. Expect to pay fees for money transfers, check requests, and other tasks. There’s also a regular, yearly fee. These costs can cancel out a good deal of the revenue that comes into your IRA.

Main Event: Buying Real Estate for the IRA

You’re in control in the sense that you make the property selections. You may find properties through regular sellers, short sellers, sellers in pre-foreclosure, banks, etc. Your IRA funds will be payment for the property.

Remember, you are not the purchaser. So your purchase contract will show the buyer as the name of the custodian firm “for the benefit of” your name and IRA account number.  

You as the investor fund your IRA with enough money to cover the purchase. Normally these are cash deals.

If, instead, you need to finance the purchase, speak with your tax pro to understand the consequences. Earnings from the property may count as taxable under certain IRS rules.

Advantages of Selling Real Estate From the IRA

At some point, you might decide to sell a property from the IRA. Here’s how.

First, you line up your buyer. You negotiate. When you and the buyer can agree on a deal, you ask the custodian to sell the property on behalf of your account.

The advantage of this type of transaction? Proceeds go straight into your IRA. Any profits you might make on the sale will be tax-deferred. If it’s a Roth IRA, they will be tax-free.

Especially if the real estate selected for the IRA gains value quickly, having it in such an account can pay off handsomely.

What’s the Rule About No Self-Dealing?

IRS rules are strict on this. Basically, no self-dealing means:

• You can’t use the IRA property yourself. Your business can’t use your IRA property. You can’t live in the property, or even work on the property or grounds.

• Your IRA can’t buy property from you, your business, or your relatives.

• Your IRA can’t sell property to someone who’s related to you.

• Your family can’t move into your IRA property. Not even if they pay rent.

• If you list an IRA property on a home-sharing platform, your relatives cannot be the paying guests.

• Every expense, every furnishing, every moment of maintenance on an IRA property must be paid for out of the IRA—never from your own checkbook or bank card. Your IRA must pay other people to do the work and manage the property.

• Any income generated by your IRA property must be paid directly into your IRA, via the custodian. The funds must stay in the IRA until you withdraw from your account in retirement.

What happens if you slip up? You can lose the tax-deferred status of the investment properties and you might even wind up facing penalties.

What Happens When the Account Holder Reaches the Age for Minimum Distributions?

Elder investors need to anticipate Required Minimum Distributions (RMDs). There comes a time in every tax-deferred account when the investor must take annual withdrawals.  

Yes, this gets a little hairy. Real estate can’t be distributed the way money can. But funds can be taken out of the account. The amount will be based on the IRA’s value at the end of the year. This involves paying for yearly appraisals for the real estate in the accounts.

It also means that money is no longer available in the account to be used for the investment properties.

But properties in IRAs could need repairs. You’ll need to maintain a hefty cash reserve inside your account. And that feat is not always easy to pull off.

If the account runs low on funds to cover maintenance and repairs or any other expenses, then what? You might have to liquidate some other asset, and transfer more money into the IRA. If you do that when you’re supposed to be taking distributions, you could run into IRS penalties.

If You Do Proceed, Proceed With Caution

Be sure to ask any company you might work with for its fee schedule. Know what it’ll cost you to close the account. Understand the process, and consider the time it will take, to sell the real estate assets.

Also, keep in mind that real estate markets have highs and lows. You could lose money if you need to exit during a downturn.

All things considered, you’ll find simpler paths to real estate investing. In fact, deed holders are already participating in investment for their retirement. If you simply buy a home, you’ll be eligible for a number of breaks when it’s time to file your tax return. Plus, you may qualify for property tax breaks.

Buying shares in real estate investment trusts (REITs) through a regular IRA is an option. Indeed, a regular, self-directed IRA lets you freely invest in a variety of funds related to real estate—investment funds that can be bought and sold quickly and conveniently.  

Important note: This article is not financial, legal, or tax advice. Each investor’s situation is unique. Ask your financial adviser about your range of alternatives before seeking a custodian for a real estate IRA.