Investing in Real Estate in Your IRA

August 5, 2013

real estateAt one time, investors set up their IRAs and purchased stocks, bonds, mutual funds and ETFs. Historically, this is how investing in IRAs has been. Investing in these products is still a very important piece of the puzzle and can create very positive long-term returns. However, using the philosophy of diversification, an increasingly popular idea is investing in actual real estate.

Can it really be done?

According to IRS Code Section 401 IRC 408(a)(3), life insurance contracts are prohibited from being held in IRAs. Further limits are listed in IRS Publication 590 where it states that an IRA will be hit with additional taxes if invested in collectibles. Those are the only limitations as far as IRS code, confirming that IRA assets may be invested in other products, such as real property.

It isn’t as simple as calling up your broker and purchasing the apartment complex down the street though. There are still a few hoops to jump through. The first thing to realize and deal with is not all IRAs and custodians allow non-traditional investments. A self-directed IRA or an IRA LLC must be created. Then a custodian that allows these investments that is also a registered trust company must be found.

One Major Stipulation

The IRS makes one thing clear about these types of investments. The property must benefit the IRA and not be for the investor’s personal benefit. This sounds very confusing, but there is some clarification offered. IRS Publication 590 has a list of prohibited transactions that would be considered “self-dealing.” Basically this means that these moves would be solely for benefit of the investor. To explain, take a look at the transactions not allowed:

  • An investor cannot use their IRA as security for a loan.
  • They cannot sell property to their IRA.
  • They cannot purchase property for personal use (present or future) with IRA funds.
  • Nor receive unreasonable compensation for managing their IRA.

If the investor, or their relatives/beneficiaries commit any of the above violations, the account loses IRA status in the eyes of the IRS as of January 1st of the year in which the violation occurs.

Another thing that an investor must be aware of before making such a movement is that all expenses for the property must be paid by the IRA and all income/rent must be paid to the IRA. The investor cannot use their personal bank account to pay for any major repairs to the property, nor can they take any of the rental income generated from that property to pay personal expenses.

What are the benefits?

Owning real estate has four true benefits to the investor:

  • An investment that does not correlate to the stock or bond markets and helps create more diversification.
  • A steady stream of funds being added to the account to cover expenses and future investments.
  • The income generated from the property is tax-free (IRAs are taxed upon distribution to the investor at the current income rate and not before).
  • Historically, real estate has increased in value regularly. All profits from the future sale would be non-taxable if kept in the IRA.

As stated above, this idea isn’t as easy as picking up the phone and calling your broker. It may be something worth looking into though.

What are your thoughts or questions about investing in real estate in your IRA? Leave a comment!


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3 Responses to Investing in Real Estate in Your IRA

  • Kirk Kinder

    Great article. Many people have been quite successful with rental properties in their IRA. The one additional point I would make is shop the IRA custodians. Since these are self-directed IRAs, the custodial costs can be high. Look to keep these as low as possible.

  • Cat Alford (@BudgetBlonde)

    That’s pretty interesting. I knew an IRA could be varied, but I’ve never thought about incorporating real estate!


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