Can I Buy Property With My IRA? What to Know

Purchasing real estate with an Individual Retirement Account (IRA) is possible but requires adherence to specific Internal Revenue Service (IRS) regulations. This investment strategy differs from traditional stock or bond investments and necessitates a particular type of IRA. Understanding the requirements and potential pitfalls is important for those considering this approach for retirement savings.

Self-Directed IRA Fundamentals

A Self-Directed IRA (SDIRA) differs from conventional IRAs by allowing a broader range of investment options beyond publicly traded securities like stocks, bonds, and mutual funds. This flexibility makes SDIRAs the vehicle for investing in alternative assets, including real estate. Unlike traditional IRAs, an SDIRA allows the account holder to direct their own investments.

The account holder makes all investment decisions and assumes all associated risks. An SDIRA still requires a custodian or trustee to administer the account and hold the assets. This specialized custodian manages administrative and reporting requirements, ensuring IRS compliance, but does not offer investment advice. Their role is passive, executing transactions based on the account holder’s instructions and safeguarding assets.

Eligible and Ineligible Real Estate Assets

A Self-Directed IRA can invest in various real estate assets, offering diversification beyond traditional financial markets. Eligible properties include residential rentals, commercial properties, raw land, mortgage notes, vacation rentals, and short-term rental properties.

The IRS prohibits certain assets from being held within any IRA. These ineligible investments include most collectibles, such as artwork, antiques, rugs, gems, and coins, with exceptions for certain U.S. minted gold, silver, and platinum coins, and high-purity bullion. Life insurance contracts and stock in S corporations are also prohibited investments for IRAs.

Prohibited Transactions and Disqualified Persons

Adhering to IRS regulations regarding prohibited transactions is important when investing with an IRA, particularly in real estate. Internal Revenue Code Section 4975 outlines these rules, designed to prevent self-dealing and personal benefit from retirement funds. A violation can lead to the disqualification of the entire IRA, resulting in immediate taxation of its full value and potential penalties.

Common prohibited transactions in real estate include borrowing money from the IRA, selling personally owned property to the IRA, or using the IRA asset as security for a loan. The IRA cannot acquire property for the personal use of the IRA owner, their family, or other disqualified persons. This includes using the IRA-owned property as a primary residence, vacation home, or for use by the IRA owner, their spouse, or lineal descendants.

“Disqualified persons” are individuals or entities with whom the IRA is prohibited from transacting. This group includes the IRA owner, their spouse, lineal ascendants (parents, grandparents), lineal descendants (children, grandchildren), and their spouses.

Any entity in which a disqualified person holds a 50% or greater interest is also considered disqualified. Transactions between the IRA and these individuals are forbidden, ensuring assets are used solely for retirement savings.

Steps for Property Acquisition

Acquiring real estate with a Self-Directed IRA involves a specific procedural path distinct from a personal property purchase. The initial step is selecting a specialized SDIRA custodian equipped to handle alternative assets like real estate. These custodians facilitate the transaction and manage paperwork and reporting.

Once a custodian is chosen, the next phase involves funding the SDIRA account. This can be achieved through rollovers from existing retirement plans (such as 401(k)s or other IRAs), direct transfers, or annual contributions, all within IRS-established limits.

After funding, the investor identifies a suitable investment property and performs due diligence, knowing the IRA, through its custodian, will be the legal owner.

When making an offer, the purchase agreement is executed by the SDIRA custodian on behalf of the IRA, not by the individual account holder. At closing, funds are disbursed by the custodian, and the property’s title is held in the name of the IRA custodian “FBO” (For the Benefit Of) the IRA owner.

All ongoing property expenses, such as property taxes, insurance, and maintenance, must be paid directly from the SDIRA. All income generated by the property, such as rental payments, must flow back into the SDIRA to maintain its tax-advantaged status.

Taxation of IRA Real Estate Investments

Real estate held within an IRA benefits from the tax-advantaged wrapper of the retirement account. Rental income and proceeds from the sale of the property grow tax-deferred within a traditional IRA, or tax-free within a Roth IRA, until distributions are taken in retirement. Expenses like property taxes, maintenance, and insurance are paid from the IRA funds, and any income received is deposited back into the IRA without immediate taxation.

A tax consideration for IRA real estate investments is Unrelated Business Taxable Income (UBTI), which can arise if the property engages in a trade or business unrelated to the IRA’s tax-exempt purpose. A common trigger for UBTI is Unrelated Debt-Financed Income (UDFI), which occurs when an IRA uses borrowed money, such as a non-recourse loan, to acquire real estate.

The portion of income generated by the debt-financed part of the investment is considered UDFI and is subject to the Unrelated Business Income Tax (UBIT), even within a tax-advantaged retirement account. The tax rate for UBIT can be substantial and requires the filing of IRS Form 990-T. When distributions are taken from the IRA in retirement, they are taxed according to the rules of the specific IRA type (e.g., traditional or Roth).