How to Buy Real Estate With an IRA

Investing in real estate offers portfolio diversification and potential long-term growth. While traditional IRAs focus on common investments like stocks, bonds, and mutual funds, certain IRAs can hold a broader range of assets, including physical real estate. This allows individuals to leverage retirement savings for real estate ventures, requiring a clear understanding of specific regulations.

Understanding Self-Directed IRAs

To invest in real estate using retirement funds, an individual must utilize a Self-Directed IRA (SDIRA). Unlike conventional IRAs, an SDIRA empowers the account holder to direct investments into alternative assets like real estate, private equity, or precious metals. Most standard IRA custodians do not facilitate real estate transactions.

The SDIRA custodian holds the assets, processes transactions, and ensures compliance with Internal Revenue Service (IRS) regulations. While the individual makes all investment decisions, the custodian executes these directives, holding the assets for the IRA owner. SDIRAs are not a separate type of IRA in terms of tax treatment. A Self-Directed Traditional IRA follows the same tax-deferred rules as a regular Traditional IRA, and a Self-Directed Roth IRA offers the same tax-free growth and distributions as a standard Roth IRA, provided IRS rules are met. Other retirement accounts, such as SEP IRAs, SIMPLE IRAs, and Solo 401(k)s, can also be structured as self-directed accounts to permit real estate investments.

Rules for IRA Real Estate Investments

The IRS imposes strict rules on real estate investments held within an IRA to prevent “prohibited transactions” that could allow the IRA owner to personally benefit. Internal Revenue Code Section 4975 outlines these restrictions. Violating them can lead to severe consequences, including IRA disqualification and immediate taxation of its entire value.

A central concept is “self-dealing,” which prohibits the IRA owner and “disqualified persons” from engaging in transactions with the IRA’s assets. Disqualified persons include the IRA owner, their spouse, ancestors, lineal descendants, and the spouses of lineal descendants. The IRA cannot purchase property from, sell property to, or lease property to any of these individuals or entities they control.

Furthermore, IRA-owned real estate cannot be used for the personal benefit of the IRA owner or any disqualified person. This prohibits living in the property, using it for vacations, or operating a personal business from it. Even performing personal maintenance or repairs is a prohibited transaction, as it constitutes providing services to the IRA. Any such transaction can cause the IRA to lose its tax-exempt status.

Steps to Investing in Real Estate Through an IRA

Investing in real estate with an IRA begins by selecting a qualified Self-Directed IRA custodian specializing in alternative assets. Research firms experienced with real estate transactions, considering their fee structures and support. Once chosen, open and fund the SDIRA account. This can be done by contributing new funds or by transferring existing retirement funds from other IRAs or qualified plans.

All due diligence, such as property inspections, appraisals, and title searches, must be conducted on behalf of the IRA. All associated costs must be paid directly from the SDIRA’s funds. When an offer is made, it must be submitted in the SDIRA’s name, not the individual’s. The purchase contract and property title documents must clearly reflect the SDIRA as the owner, typically in the format “XYZ Custodian FBO [Your Name] IRA.”

The SDIRA custodian facilitates the transaction by disbursing funds from the IRA to complete the purchase. The custodian holds the property title on behalf of the IRA, ensuring legal ownership is attributed to the retirement account. This ensures the investment remains within the IRA’s tax-advantaged structure from acquisition.

Ongoing Management and Tax Considerations

Once real estate is acquired within an IRA, strict rules govern its ongoing management to maintain its tax-advantaged status. All property income, such as rental payments, must flow directly into the SDIRA. All related expenses, including property taxes, insurance, maintenance, and utilities, must be paid directly from the SDIRA’s funds. The IRA owner cannot personally pay for these expenses or receive direct income from the property.

A tax consideration for IRA real estate investments is Unrelated Business Taxable Income (UBTI). While passive rental income is generally not subject to UBTI, this tax can be triggered if the property is debt-financed or if the IRA engages in an active trade or business beyond passive rentals. If a non-recourse loan is used to purchase real estate within an IRA, the portion of income attributable to that debt financing is considered Unrelated Debt-Financed Income (UDFI), a type of UBTI. This debt-financed income is taxed at trust tax rates, which can reach up to 37% for taxable income, and requires the filing of IRS Form 990-T if gross UBTI is $1,000 or more. When the property is sold, all proceeds must return to the SDIRA, preserving the tax-deferred or tax-free status of the gains.