We often get questions from our clients about buying real estate in their IRAs, such as:
- Can we help our children buy a home using IRA money?
- Can we buy a vacation home in an IRA?
- Can we buy an investment property, such as a rental home or condo in our IRA?
- What type of real estate investment is appropriate for an IRA?
These are the questions we’ll explore in this issue.
Often, it does not make sense to buy individual properties inside your IRA because of the restrictions put in place by our tax laws. These restrictions include:
- No mortgage loans for the purchase of property in the IRA — This forces you to pay the entire price of the property with your IRA funds. If you purchase an investment property in your IRA, you lose the advantage of leverage that a mortgage provides.
- No personal use — You are not permitted to buy a property and use it for personal purposes. The definition of personal use includes use by yourself, your spouse, your children, or your parents. This makes the purchase of a timeshare, vacation property, or primary residence for your children all but impossible.
- Can’t rent the property to your own business — You can’t purchase real estate and then rent it to your business.
- Must be a new purchase — You can’t place property you already own in your IRA.
- IRA custodian must approve — Many IRA custodians do not permit the purchase of real estate in your IRA. Those custodians that do usually charge fees for this service that range from 0.40% to 1.5%. Your IRA custodian may also require you to hire a property manager.
- You’ll need extra cash or liquidity — You’ll need cash in the IRA for repairs, taxes, assessments, etc.
Here’s where direct ownership of real estate might work
- If you have a large IRA relative to the price of the property — Direct ownership of real estate can work when your IRA balance is large enough to cover the cost of the property and your overall portfolio (both retirement and taxable) is large enough to provide diversification. We usually recommend that your total real estate allocation not represent more than 5% to 10% of your overall portfolio. For example, if all of your investments are in your IRA and its value is $1 MM or more, you could purchase a piece of real estate valued at $100,000 and meet the conditions we’ve recommended. The advantage would be that any income earned from the property would be tax deferred.
- Purchasing a rental property in a Roth IRA and converting it to a primary residence after age 59½. If you owned the rental property in a Roth, all of the rental income would be tax free. In addition, after you’d turned age 59½ and decided you wanted to move into the property, the Roth IRA would transfer ownership to you and you would pay no taxes on the transfer. Therefore, all the gains up to that time would be tax free.
The more common approach
The most common way to own real estate in your IRA is through the use of Real Estate Investment Trusts (REITs). REITs are companies that invest in various types of real estate and mortgages. They provide diversification and a good combination of income and growth for investment return. You purchase shares in a REIT as you would a stock, or you can purchase REIT mutual funds. These types of investments satisfy all of the tax law restrictions.
While it may be possible for you to buy individual real estate properties in your IRA, the tax law restrictions make it rather difficult for most investors. REITs are the preferred way for our clients to participate in the real estate investment market. However, if you have a specific question about holding property in your IRA, please do not hesitate to contact us.