Can You Buy Real Estate With an IRA?

An Individual Retirement Account (IRA) can be used to invest in real estate, but this requires a specialized Self-Directed IRA (SDIRA). Unlike traditional IRAs that limit investments to stocks, bonds, and mutual funds, an SDIRA expands choices to include alternative assets like real estate. This allows individuals to diversify their retirement portfolios. Investing in real estate through an IRA requires careful adherence to Internal Revenue Service (IRS) regulations to maintain the account’s tax-advantaged status.

The Self-Directed IRA Vehicle

A Self-Directed IRA (SDIRA) provides the account holder with greater control over investment decisions, allowing for a broader range of assets beyond traditional stocks and bonds. It enables investment in alternative assets like real estate, precious metals, and private equity, which are not typically available in conventional IRA accounts.

An IRS-approved custodian or administrator plays a central role in an SDIRA, holding the assets and ensuring compliance with IRS regulations. While the investor directs specific investments, the custodian executes these instructions, processes transactions, and handles necessary paperwork and reporting to the IRS. This custodial oversight is fundamental to preserving the IRA’s tax-deferred or tax-free status.

Establishing an SDIRA involves selecting a qualified custodian that supports alternative investments, as not all financial institutions offer this service. The process generally includes completing an application and funding the account. Funding options typically involve transferring funds from existing retirement accounts, such as a 401(k) or another IRA, or making new contributions within annual IRS limits.

Permitted and Prohibited Real Estate Transactions

Investing in real estate through an SDIRA is subject to strict IRS regulations to prevent self-dealing and ensure the account remains for retirement purposes. Permitted real estate investments include residential property, commercial property, raw land, and certain mortgage notes, provided the property is solely for investment purposes. The IRA, not the individual, must legally own the property, with all related documents held in the SDIRA’s name for the account holder’s benefit.

SDIRA compliance involves understanding “prohibited transactions” as defined by IRS Code Section 4975. These are transactions between the IRA and “disqualified persons.” Disqualified persons include:
The IRA owner
Their spouse
Lineal ascendants (parents, grandparents)
Lineal descendants (children, grandchildren, and their spouses)
Any entity where these individuals hold a significant ownership interest (50% or more)

Prohibited transactions prevent personal benefit from IRA-owned property. The IRA owner or a disqualified person cannot live in, vacation at, or use the property for their personal business. The IRA cannot purchase property from or sell property to a disqualified person, nor can it lend money to them or guarantee their loans. Disqualified persons are also prohibited from providing services, such as repairs, maintenance, or management, to the IRA-owned property; all such services must be performed by independent third parties.

Engaging in a prohibited transaction carries severe consequences. If one occurs, the IRA is treated as if it ceased to be an IRA on the first day of the year the transaction took place. This results in the entire account balance being considered a taxable distribution at fair market value, potentially subjecting the owner to ordinary income tax and, if under age 59½, an additional 10% early withdrawal penalty. Disqualified persons involved may also face excise taxes, initially at 15% of the amount involved, with an additional 100% tax if the transaction is not corrected.

Funding and Acquiring Real Estate

Funding a Self-Directed IRA for real estate investment requires careful planning to ensure sufficient capital is available. Annual contributions can be made to the SDIRA, adhering to IRS-mandated limits. A common method for accumulating substantial funds is through rollovers or direct transfers from existing retirement accounts, such as traditional IRAs, Roth IRAs, or employer-sponsored plans like 401(k)s. These transfers move funds without triggering immediate taxation.

The SDIRA must hold enough funds to cover the entire real estate purchase, including the property price, closing costs, and ongoing expenses like property taxes, insurance, and maintenance. All funds for acquisition and subsequent expenses must originate directly from the SDIRA account. The IRA owner cannot personally pay for these expenses and then seek reimbursement from the IRA, as this would violate prohibited transaction rules.

The real estate acquisition process through an SDIRA involves specific procedural steps, with the custodian facilitating all transactions. Once an investor identifies a property and completes due diligence, the offer to purchase and all related legal documents, such as the title, must be executed in the SDIRA’s name. The custodian then processes the purchase, ensuring all funds flow directly from the SDIRA to the seller.

For real estate purchases where the SDIRA does not have enough cash, a non-recourse loan may be utilized. A non-recourse loan is a type of financing where the IRA account holder is not personally liable for repayment. The loan is secured solely by the purchased property. In the event of default, the lender can only pursue the property as collateral and cannot seek repayment from the IRA owner’s personal assets or other assets within the IRA. This financing is required for SDIRA real estate investments to prevent the IRA owner from personally guaranteeing the loan, which would constitute a prohibited transaction.

Tax Treatment of Real Estate Investments

Real estate investments held within a Self-Directed IRA benefit from the same tax advantages as other IRA assets. Rental income and capital gains from property sales grow tax-deferred within a Traditional SDIRA. For a Roth SDIRA, these earnings can grow tax-free, and qualified distributions in retirement are also tax-free. This allows for compounding growth without annual taxation on income or appreciation.

A tax consideration for SDIRA real estate investments, particularly when leverage is involved, is the Unrelated Business Income Tax (UBIT). UBIT can apply if the SDIRA uses debt financing, such as a non-recourse loan, to acquire real estate. The portion of income generated from the debt-financed property may be subject to UBIT, even within a tax-advantaged retirement account. This tax is reported on IRS Form 990-T and is calculated on the net income attributable to the debt-financed portion of the asset.

Distributions from an SDIRA holding real estate depend on the IRA type. Distributions from a Traditional SDIRA are generally taxed as ordinary income upon withdrawal in retirement. For Roth SDIRAs, qualified distributions are tax-free. Required Minimum Distributions (RMDs) apply to Traditional SDIRAs once the account holder reaches age 73. Satisfying RMDs with illiquid assets like real estate can present challenges, as the property may need to be sold to generate cash. Strategies such as taking the RMD from other liquid IRA accounts or, in some cases, an in-kind distribution of a portion of the property, may be considered to fulfill the requirement.