Self-Directed IRA's Investing in Real Estate

Since many of our clients enjoy investing in real estate, we thought there would be an interest in the rules that govern purchase of real estate in a self-directed IRA account.

Generally, IRAs do not allow the following investments:
Life insurance
  • Collectibles (e.g., artwork, antiques, metals, gems, and most coins)
  • S corporations
All other types of investments are permitted. This means that an IRA can purchase any form of real estate. Investing in real estate for your retirement may serve as a means to diversify your retirement portfolio to hedge against the cyclical changes in the stock market.
A clean real estate investment in an IRA is one where the real estate is purchased in full for cash from an unrelated party and there is no personal use. In other words, you treat it strictly as an investment.
If your IRA invests in real estate through a down payment and the remainder with a mortgage then there are some significant issues that must be addressed to avoid tax exposure. These are as follows:
  1. The mortgage in the IRA may not be personally guaranteed
  2. The IRA custodians will probably limit the amount of debt that the IRA can carry
  3. A bank may not allow the IRA to be the debtor without a personal guarantee
  4. The IRA will need to pay tax on the unrelated mortgage interest income. This is the income and / or capital gains attributable to the mortgage portion. These taxes are higher than would be paid on income generated from a property that you buy and finance personally. In addition, these taxes must be paid from funds from the IRA. This means that there needs to be enough other assets in the IRA to cover these taxes.
Due to the above, having a mortgage in an IRA has additional complexities to it that make it less desirable then if the real estate can be purchased outright.
Some more rules:
  • You cannot directly or indirectly buy real estate from a "disqualified person". A disqualified person is any of the following:
    • The IRA owner
    • The IRA owner's spouse, descendant, or ascendant
    • Spouse of a descendant of the IRA holder
    • A trustee or custodian of the IRA
    • An entity that is at least 50% owned by any of the above
    • A 10% owner, officer, or director or highly compensated employee of such an entity
  • The IRA cannot purchase real estate and then have a disqualified person use it while it is in the IRA. In other words, you cannot buy a vacation home and use it partially for personal use even though you might rent it to unrelated persons the rest of the year.

As outlined above, buying real estate from an unrelated party with cash is the simplest way of investing in real estate with your IRA. Your IRA can buy raw land, commercial property, residential rental property, real estate options, as well as first and second mortgages secured by real estate.

Even though it is easiest to by the real estate in full with cash, this is often not possible for many investors. There are still a variety of ways that an IRA can participate in a real estate investment without a full cash capital investment. For example, your IRA can co-invest with other parties. You could also have your IRA, and other parties participate in real estate investing by becoming members of an LLC that buys and sells property.

We hope that this article gives you some insight on the rules for buying real estate in an IRA. There is a number IRA custodian firms that will provide you with ongoing professional guidance to help make sure that you stay in compliance with the tax rules. Our firm would be happy to provide you with additional details on this subject should this be of interest to you.
 
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