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Investing in Real Estate? Don’t Ignore IRA Funds

Realtor at Open House

  |  By Matthew White, CISP

With the US housing market rebounding and the economic recovery strengthening, real estate is an increasingly attractive asset class for investors looking to save for retirement. Investing in real estate can provide portfolios with much-needed diversification as well as the potential for capital gains.

While many real estate professionals are very comfortable working with clients who use their taxable accounts to make a real estate investment, many professionals I speak with are not aware that clients often have access to another source of capital that can be used to buy real estate: a retirement account.

Personal retirement funds, like those held in self-directed IRAs, are an often overlooked source of capital because most investors (and real estate pros) do not know it’s possible to invest IRA funds beyond stocks, bonds and mutual funds.

But self-directed IRAs give account owners control over choosing their investments and they can use IRA funds to participate in almost any form of real estate investment -- from condominiums and office complexes to REITs or tax liens.

Using an IRA to invest in real estate provides clients with the added benefit of investing with tax-advantaged dollars. When a real estate investor uses retirement dollars, in most, if not all cases, capital gains are avoided and taxes on income from return on investment are deferred until it's time to take distributions.

If the investor uses a Roth IRA, in many cases account holders can avoid paying taxes on distributions or profit generated by the sale of the property entirely. (In all cases, reviewing the investment with a tax professional is a good idea.)

Here are some of the most common ways I work with PENSCO clients who choose to invest in real estate:

  1. Direct purchase:

    The IRA buys the entire property outright using funds in the account. The income and expenses flow directly in and out of the IRA.
  2. Partnerships or tenants-in-common purchase:

    These transactions combine the investor’s IRA funds with other investors’ funds or in conjunction with the IRA owner’s non-IRA funds. The investment income and expenses are handled proportionate to each entity’s ownership amount.
  3. Mortgage-backed purchase:

    In these purchases, the IRA borrows money to purchase property. Important caveats to note are that neither the IRA, nor the account owner, can have any personal liability in the mortgage (investors cannot back their own loans). A non-recourse loan must be used so that the lender can only seize the actual property being purchased and not the rest of the IRA’s assets if the borrower defaults on the loan. All mortgage payments are made with IRA funds. In addition, if property purchased in an IRA is financed by debt, income produced by that property, as well as gain on sale, could be subject to tax. It’s always best to consult with a tax professional in these situations.
  4. Limited liability company:

    In these transactions the property title is held in the name of the LLC. In this case, the IRA holds an interest in the LLC rather than title to the property.

Buying and maintaining real estate in an IRA differs from traditional property investments in a few important ways. For instance, regardless of the asset type, the investment must be purchased with funds held in the IRA and the title needs to be vested in the name of the IRA custodian for the account.

There are also certain regulations that you and your clients need to be aware of when it comes to investing in real estate with a self-directed IRA. One example is that self-directed IRAs are prohibited from holding any assets that are used for the owner’s personal benefit – so your client cannot buy a home with IRA funds and then live in it.

Understanding how investors can use self-directed IRAs to invest in real estate can help you get a leg up on the competition and grow your business.

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.