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Why “Can’t” I Use My IRA For Real Estate Investment Property?

  • July 16, 2020

Imagine investing in real estate worth $250,000 today and selling it 15 years from now at $700,000 without incurring tax-related charges. This is what can happen when you use your IRA investment to buy real estate. More people who save for retirement benefits realize that they have other options other than the conventional bonds, EFTs, mutual funds, and stocks.

What Is an IRA?

An individual retirement account (IRA) is a form of investment that allows you to save towards your retirement while taking advantage of certain tax benefits. The tax benefits depend on whether you take a traditional or Roth IRA. Both of these plans allow you to save $6,000 every year ($7,000 if you are 50 years or older). This amount is standard even if you have other workplace saving plans such as 401(k).

If you choose a traditional IRA, you access this money at any time. You will be taxed and incur a 10% surcharge if you access the money before you reach 59½ years. When it comes to a Roth IRA, you will not be able to deduct your contributions. You can withdraw your money tax-free once you retire.

Normal vs. Self-Directed IRA

In a normal IRA, your monies are overseen by an investment advisor or a broker, and you can only invest in bonds, mutual funds, and the stock market. As the name suggests, a self-directed IRA gives you complete control over your investment. You can invest in antiques, collectibles, cryptocurrency, precious stones, real estate, and tax liens.

In both cases, you have to work with a custodian. In a normal IRA, the custodian has a responsibility to secure your financial future. Therefore, only they have the authority to direct your investment. In a self-directed IRA, the custodian plays a passive role, which means that they can only advise you about where you should invest, but you will have the final word.

Investing in real estate through a self-directed IRA

Real estate is fast becoming a popular retirement investment among self-directed IRA account holders as it is a tangible asset that can be a steady source of income for years on end. Besides, real estate has been proven to appreciate with time, depending on the type of property and its location.

When buying a property through self-directed IRA, you can buy any type of property, including a commercial building, single or multi-family rental units, or undeveloped land. However, you cannot buy such property to develop it or use it for personal use. This rule is not limited to the property only but also everything else within. For instance, you cannot take the furniture in your IRA rental property for personal use. You cannot use the money in your self-directed IRA account to buy a property you already own.

When investing in real estate through a self-directed IRA, you can only buy the property in cash, which means that you cannot borrow money or use a mortgage to purchase the property.

You are not allowed to pay for any expenses for the property directly. Rather, you can only pay through your IRA account. As such, all costs of purchasing the property, including repairs, fees, taxes, insurance, and closing costs, have to come from the IRA account. If there are no sufficient funds in your account to meet these expenses, you can partner with a family member or a colleague who becomes a non-disqualified person. The expenses incurred or the income gained from such property is divided according to the percentage each party owns.

As with a normal IRA, all your real estate investments will be tax exempted or tax-deferred. Tax-deferral means that you will pay the taxes at a later date.

Why involve property managers?

Unless your IRA custodian is licensed to manage real estate then you must have the custodian hire a property manager for your investment. Locate a strong manager using a company such as that will, at no cost to the IRA, locate a qualified manager. Because property managers are experts in real estate management and marketing the additional income you gain will probably offset any expense of management.

The bottom line

While you could earn more by investing in real estate, this mode of investment is not completely fool-proof. Your IRA custodian will explain all you need to learn about your investment’s tax implications, timelines, and processes. They will also explain all the do’s and don’ts of such and investment. On the other hand, your property manager should be able to handle all the challenges that real estate investors have to deal with including economic contractions, property management, and spikes in interest rates.

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