Can an IRA Buy Real Estate?

Investing retirement funds in real estate is possible for an Individual Retirement Account (IRA), but this investment path is not available through all types of IRAs. This strategy primarily involves a Self-Directed IRA, which is designed to hold alternative assets beyond traditional stocks and bonds. Investing in real estate within an IRA requires adherence to Internal Revenue Service (IRS) regulations to avoid penalties and maintain the tax-advantaged status of the retirement savings.

Understanding Self-Directed IRAs for Real Estate

A Self-Directed IRA (SDIRA) is a specialized retirement account that allows the account holder to invest in a broader range of assets than typical IRAs. Unlike standard IRAs that usually limit investments to publicly traded securities, SDIRAs provide the flexibility to include alternative assets such as real estate, private equity, and precious metals. This expanded investment choice makes SDIRAs the required vehicle for individuals looking to use their retirement funds to purchase real property.

The core distinction of an SDIRA lies in the investment control and administrative oversight. While the individual directs the investment decisions, a qualified custodian or trustee is legally required to administer the account. This custodian holds the assets on behalf of the IRA, processes transactions, and ensures compliance with IRS reporting requirements. The custodian acts as an independent third party, safeguarding the assets and facilitating the investment process as directed by the IRA holder.

Various types of IRAs can be self-directed to hold real estate, including Traditional IRAs, Roth IRAs, SEP IRAs, and SIMPLE IRAs. The “self-directed” designation refers to the investment options available within the account, not its tax treatment. For instance, a Self-Directed Roth IRA maintains its tax-free growth and tax-free withdrawals in retirement, while a Self-Directed Traditional IRA offers tax-deferred growth. The choice of SDIRA type depends on an individual’s tax strategy and retirement goals.

Permissible Real Estate Investments and Prohibited Transactions

Individuals utilizing a Self-Directed IRA can invest in a wide array of real estate types. Permissible real estate investments generally include residential rental properties, commercial properties, raw land, and notes secured by real estate. Real Estate Investment Trusts (REITs) and private real estate funds are also viable options for diversification within an SDIRA portfolio.

Despite the broad investment possibilities, the IRS imposes strict rules to prevent self-dealing and personal benefit, primarily through “prohibited transactions.” A “disqualified person” is broadly defined and includes the IRA holder, their spouse, their ancestors, their lineal descendants, and any spouse of those descendants. Entities where disqualified persons own 50% or more of the interest are also considered disqualified. Transactions between the IRA and any disqualified person are forbidden.

Examples of prohibited transactions include an IRA purchasing property from, or selling property to, a disqualified person. The IRA holder or any disqualified person cannot personally use the property, which means living in it, vacationing there, or using it for a personal business is not permitted. Furthermore, the IRA holder cannot perform personal labor on the property; all work must be performed by third-party contractors paid by the IRA. Receiving any direct current benefit from the property, such as collecting rental income personally, also constitutes a prohibited transaction.

Engaging in a prohibited transaction has significant repercussions. If such a transaction occurs, the IRA is treated as if it was fully distributed on the first day of the year in which the transaction took place. This means the entire fair market value of the IRA’s assets becomes immediately taxable income to the IRA owner. If the IRA holder is under age 59½, a 10% early withdrawal penalty may also apply.

The Real Estate Acquisition Process

Acquiring real estate through a Self-Directed IRA involves a specific procedural flow, beginning after the account has been established. The first step involves selecting a qualified SDIRA custodian specializing in alternative assets, particularly real estate. A custodian familiar with real estate transactions can help navigate complexities and ensure compliance.

Once a custodian is chosen, the next step is funding the SDIRA. This can be accomplished through rollovers from existing retirement accounts, such as a 401(k) or another IRA, or by making new annual contributions within IRS limits. The funds are transferred to the SDIRA custodian, who then holds them in trust for the benefit of the IRA. The IRA must have sufficient capital for the property purchase and ongoing expenses.

With the SDIRA funded, the account holder identifies a suitable investment property that aligns with IRS rules, particularly avoiding any prohibited transactions. The property must be acquired for investment purposes only, without any direct or indirect benefit to the IRA holder or disqualified persons. The IRA holder then instructs the custodian to make an offer on the selected property.

All real estate transactions must be executed by the SDIRA custodian. The offer to purchase is made in the name of the IRA, with the custodian listed as the buyer for the benefit of the IRA holder. The custodian facilitates the purchase, handles the necessary paperwork, and ensures that the property’s title is correctly vested in the name of the IRA.

Managing and Maintaining Real Estate within an IRA

After an IRA acquires a real estate asset, ongoing management and expenses must adhere to IRS regulations. All property-related expenses, including property taxes, insurance premiums, maintenance costs, repairs, and homeowners’ association (HOA) fees, must be paid directly from the IRA’s funds. The IRA holder cannot use personal funds to cover these expenses. The custodian processes these payments from the IRA’s cash balance upon instruction from the IRA holder.

Similarly, all income generated by the property, such as rental payments, must flow directly back into the IRA account. This income is reinvested within the IRA, contributing to its tax-deferred or tax-free growth, depending on the account type. The IRA holder cannot personally receive or use any rental income or sale proceeds; these must remain within the retirement account.

A unique tax consideration for real estate held in an IRA, particularly if debt is involved, is Unrelated Business Taxable Income (UBIT). If the IRA uses a non-recourse loan to finance a portion of the property’s purchase, the income attributable to the debt-financed portion may be subject to UBIT. This is known as Unrelated Debt-Financed Income (UDFI). UBIT is levied at trust tax rates, and the IRA itself is responsible for paying this tax by filing Form 990-T.

When the time comes to sell the property, the process is again managed by the SDIRA custodian. The custodian handles the sale transaction, and the proceeds from the sale are returned directly to the IRA. These funds remain within the IRA, available for future investments or eventual distribution during retirement. Distributions from the IRA will be taxed according to the rules of the specific IRA type.