Can You Buy Real Estate With a Roth IRA?

A Roth IRA functions as a tax-advantaged retirement savings vehicle, allowing contributions made with after-tax dollars to grow and be withdrawn tax-free in retirement, provided certain conditions are met. A common inquiry among investors is whether real estate can be included as an asset within these accounts. It is indeed possible to acquire real estate using Roth IRA funds, but this can only be achieved through a specific type of retirement account designed for broader investment options, known as a Self-Directed IRA. This approach offers a pathway to diversify retirement portfolios beyond traditional stocks and bonds, though it involves navigating specific IRS regulations.

Understanding Self-Directed Roth IRAs

A Self-Directed Roth IRA (SDIRA) stands apart from conventional Roth IRAs by offering the account holder greater control over investment choices. While typical Roth IRAs often restrict investments to publicly traded securities like stocks, bonds, and mutual funds, an SDIRA permits a much wider array of alternative assets, including real estate, private placements, and precious metals. This flexibility is the defining characteristic that makes real estate investment possible within a Roth IRA structure.

The operation of an SDIRA involves a specialized custodian, approved by the IRS. This custodian is an administrative entity responsible for holding assets, processing transactions, and ensuring IRS compliance. When real estate is purchased, the SDIRA, through its custodian, becomes the legal owner of the property, not the individual account holder. The custodian manages all investment-related funds, including purchase, rental income collection, and expense payments, maintaining the account’s tax-advantaged status. The account holder makes all investment decisions, from asset selection to due diligence, while the custodian handles custodial duties and record-keeping.

Permissible Real Estate Investments and Prohibited Activities

A Self-Directed Roth IRA can hold a diverse range of real estate assets, provided they are acquired and held solely for investment purposes. Permissible investments include residential and commercial rental properties, raw land, real estate notes, tax liens, and even fractional real estate interests. The overarching requirement is that the property must generate income or appreciate in value for the benefit of the IRA, rather than providing any direct or indirect personal benefit to the IRA owner or certain related parties.

SDIRA real estate investing requires strict adherence to “prohibited transactions” as defined by Internal Revenue Code Section 4975. These rules prevent self-dealing and conflicts of interest, ensuring IRA assets are used exclusively for retirement savings. Prohibited transactions include the IRA owner or any “disqualified person” (e.g., spouse, parents, grandparents, children, grandchildren, and their spouses) personally using the property, selling property to or buying property from the IRA, or providing services to the IRA-owned property. For instance, living in an IRA-owned property, managing it yourself, or having a disqualified family member perform repairs are prohibited transactions. Engaging in a prohibited transaction can lead to severe consequences, including loss of the IRA’s tax-advantaged status, making the entire account’s value immediately taxable and subject to penalties.

The Real Estate Acquisition Process

Acquiring real estate with a Self-Directed Roth IRA involves a structured process that prioritizes compliance with IRS regulations and the custodian’s oversight. The initial step involves selecting a reputable SDIRA custodian that specializes in alternative asset investments, as not all custodians offer real estate options. Once an account is established, it must be funded through contributions, rollovers from other retirement accounts, or transfers.

After funding, the account holder identifies a suitable investment property and conducts due diligence, similar to any direct real estate purchase; however, all transactions, including purchase, sale, and ongoing expenses, must be executed through the SDIRA custodian. The IRA, through its custodian, is the legal entity that owns the property, and all legal documents, such as deeds and contracts, will reflect the IRA as the owner. The account holder directs the custodian to perform these actions by submitting specific investment direction forms and supporting documentation. For ongoing management, day-to-day operational tasks like collecting rent or arranging maintenance must be handled by an independent third party or directed through the custodian to avoid prohibited transactions. All income generated by the property and all expenses incurred must flow directly into and out of the IRA account, respectively.

Addressing Unrelated Business Taxable Income

While a Roth IRA generally provides tax-free growth and distributions, certain income from real estate held within an SDIRA can be subject to Unrelated Business Taxable Income (UBTI). UBTI is a tax on income a tax-exempt entity, like an IRA, earns from an “unrelated trade or business” regularly carried on by it. The primary trigger for UBTI in the context of real estate IRAs is the use of debt-financed property.

If an IRA uses a loan, such as a non-recourse mortgage, to acquire real estate, a portion of the property’s income proportional to the debt may be subject to UBTI. This is known as Unrelated Debt-Financed Income (UDFI), a subset of UBTI; for example, if a property is purchased with 50% debt financing, 50% of the net income could be subject to UBTI. The UBTI rules prevent tax-exempt entities from having an unfair advantage in activities typically conducted by taxable businesses. If gross UBTI for an IRA exceeds $1,000, the IRA itself, not the individual, must file IRS Form 990-T, “Exempt Organization Business Income Tax Return,” and pay any taxes due. The tax rates applied to UBTI for IRAs are generally trust tax rates, which can be significant.