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5 Tips for Investing in Real Estate with Your IRA

A Man Thinking About Real Estate

  |  By Chris Shanahan, CISP®

Investing in real estate is a popular strategy among self-directed IRA owners, who are drawn to the asset for its diversification benefits, as well as its potential for price appreciation and possible steady income stream in the form of monthly rental payments. However, there are some nuances to investing in real estate with your self-directed IRA that differ from buying property outright with your taxable dollars.

For real estate investors, here are five things to keep in mind if you are considering buying an investment property with your IRA:

  1. Make sure no disqualified person, including yourself, uses or inhabits the investment property. It might sound like a fantastic idea to buy a beachfront property with IRA funds to use as a vacation property for you and your family. However, this is a huge no-no. Purchasing property with IRA funds for your personal benefit is considered by the IRS to be a prohibited transaction. You may not benefit personally from an investment held in your retirement account, meaning that you cannot live or stay in the investment property. The same restrictions apply to your children, parents, your grandparents or any other "disqualified person" as defined by the IRS. When buying real estate with your IRA, the property is meant for retirement investment purposes only and cannot be personally used for personal benefit.
  2. Do not perform any “sweat equity” on the property. Remember, when investing in real estate with your IRA, your IRA owns the property — not you. That means rules and regulations prevent you (or any other disqualified person) from personally performing any work on the property, like mowing the lawn or changing a light bulb. IRA owners are required to have a third party, such as a property manager, perform any tasks related to upkeep of the property, including taking care of the landscaping, and making all repairs and upgrades.
  3. Consider hiring a property manager. A property manager can handle all paperwork related to the investment property including billing, collecting rent or paying expenses. In this way, a property manager can act as an intermediary between you and your IRA custodian. Not only does this make life easier for you, it also keeps you at arm's-length from the property, helping to avoid any potential prohibited transactions.
  4. Keep enough cash in your IRA to cover expenses. With any direct real estate investment made via an IRA, all expenses, maintenance costs and property taxes must be paid with cash from the IRA that owns the property. You are not allowed to pay bills related to the investment property with your personal checkbook or your personal savings account (or personal credit cards). If a contractor performs repairs on your investment property, the contractor needs to invoice your IRA — not you — directly for the cost.
  5. Fill out your deed and tax bill correctly. Because property taxes for the investment property must be paid with IRA cash, it is crucial that your paperwork is set up correctly. Make sure the name on the deed and tax bill is listed as “[Name of your IRA Custodian] FBO [Your Name]” and the address on your property taxes is the IRA custodian's address. Many IRA custodians, including PENSCO, prefer that the address on tax bills is the address of the custodian so there is no confusion about where tax bills should be delivered. Your custodian can coordinate that payment with you when the bill is received. This enables you to avoid the possibility of accidentally paying taxes with personal funds, and your IRA custodian can take care of the related administrative functions. Note: If your property is financed or partially financed with debt, or acquired via a pass-through fund, your real estate investment could generate UBTI (Unrelated Business Taxable Income). Contact your financial advisor to discuss the specifics of your investment and whether it could incur UBTI, and how this might affect you come tax time.

To learn more about rules around purchasing an investment property using your self-directed IRA, download our real estate investing guide, or call us directly at (866) 818-4472.

This Blog does not provide investment, tax, or legal advice nor does it evaluate, recommend or endorse any advisory firm or investment vehicle. Investments are not FDIC insured and are subject to risk, including the loss of principal.

PENSCO Trust Company performs the duties of an independent custodian of assets for self-directed individual and business retirement accounts and does not provide investment advice, sell investments or offer any tax or legal advice. Clients or potential clients are advised to perform their own due diligence in choosing any investment opportunity as well as selecting any professional to assist them with an investment opportunity. Alternative investments are not FDIC insured and are subject to risk, including loss of principal. Other than the Opus Affiliates, PENSCO is not affiliated with any financial professional, investment, investment sponsor, or investment, tax or legal advisor.