Retire Like a Boss: Learn How to Buy Real Estate Using Your IRA

Planning for retirement can be made easier with the inclusion of an individual retirement account (IRA) in your portfolio. However, many people are unaware they can use their IRA to invest in real estate and further enhance their savings. Discover the advantages of having a real estate IRA and learn how to steer clear of any potential pitfalls. It’s important to seek guidance and advice from a financial advisor if you’re thinking of investing in real estate.

The Importance of an IRA: 

An IRA is a tax-advantaged financial account to help individuals save for retirement. Various financial institutions and brokerages offer it, providing a wide range of investment opportunities. Unlike a 401(k) plan, an IRA is not employer-dependent. Each year, the IRS sets a contribution limit for IRAs. As of 2024, the limit is $6,500 ($7,500 for participants aged 50 and above) or the annual taxable income, whichever is lower. Three types of IRAs are available: traditional IRA, Roth IRA, and IRA CD. Each offers different benefits, such as tax-free or tax-deferred savings and investments. Funds in an IRA can be invested in various assets, including mutual funds, target date funds, ETFs, stocks, bonds, and CDs. The growth of these investments remains in the IRA until retirement age, at which point it can be withdrawn either tax-free or at the prevailing tax rate, depending on the type of IRA.

Using Your IRA to Purchase Real Estate: 

Apart from conventional investment choices, an IRA can be used to invest in real estate, providing better portfolio diversification. The following steps outline the process:

Step 1: Choose a Self-Directed IRA: 

To begin, open and fund a self-directed IRA. These specialized accounts, offered by select financial institutions, allow alternative investments for retirement savings. It is important to note that with a self-directed IRA, the property is owned by the IRA, not the individual. Thus, a clear separation between personal and IRA funds must be maintained.

Step 2: Select a Custodian:

 Unlike traditional or Roth IRAs, self-directed IRAs require a custodian to manage the account. The custodian, who charges a fee, ensures compliance with IRS regulations and handles financial reporting. Not following these rules could result in the IRA being disqualified, which could put retirement savings at risk and cause taxable events. It is crucial to understand that custodians do not serve as financial advisors and do not provide investment guidance.

Step 3: Choose an Investment Property: 

When using your real estate IRA, the purchased property must be considered an investment property. It cannot be used as a vacation home, a secondary residence, or for personal purposes. Violating these rules can have serious financial consequences. The IRS defines “disqualified” individuals who cannot utilize the investment property. Disqualified individuals include spouses, parents, grandparents, siblings, property co-owners, and lineal descendants, such as children, grandchildren, and great-grandchildren.

Step 4: Complete the Purchase: 

Purchasing real estate with an IRA can be challenging. Since the self-directed IRA owns the property and not the individual, obtaining mortgage approval may be difficult. Consequently, many investors choose to buy properties outright, which can limit investment options based on the IRA balance.

Step 5: Property Management: 

As the IRA technically owns the investment property, it covers taxes, maintenance, and management expenses. It is essential to allocate sufficient funds from the IRA to handle these costs. While avoiding paying these expenses personally can be advantageous, unforeseen large expenses may require additional contributions. Exceeding the IRS annual contribution limit will result in penalties. It is important to consider that every dollar withdrawn from the IRA before retirement is a missed opportunity for future growth, potentially affecting retirement savings.

Step 6: Capitalizing on Property Gains: 

As the property owner, the IRA will benefit from any growth when it is sold. The gains from the sale will be deposited into the IRA, boosting retirement savings without the same tax implications as personal buying and selling.

Requirements and Tax Implications: 

Real estate IRAs have specific requirements and tax implications that must be considered:

  • A self-directed IRA must be opened, as traditional or Roth IRAs do not support real estate investments.
  • Disqualified individuals, including immediate family members and business partners, cannot utilize the investment property.
  • The IRA manages the property and covers expenses exclusively using IRA funds.
  • Tax deductions, such as depreciation, property taxes, eligible expenses, and mortgage interest, are not applicable to real estate IRAs. However, the usual IRA tax benefits remain intact, depending on the IRA’s structure.

Advantages of Real Estate IRAs

Investing in real estate using an IRA offers several advantages worth considering:

  • Diversification: Adding real estate to your IRA portfolio can help mitigate market downturns and increase security.
  • Cost Coverage: Since the property is managed by a custodian and owned by the IRA, out-of-pocket expenses and taxes associated with property ownership are alleviated.
  • Predictable Appreciation: Real estate often appreciates steadily, providing a reliable avenue for retirement savings growth.
  • Tax-Free Income: Rental income generated by the investment property can grow within the IRA without immediate tax consequences.

Disadvantages of Real Estate IRAs

Before pursuing real estate investments with an IRA, it is important to be aware of the potential drawbacks:

  • Custodian Management: Self-directed IRAs require a custodian to oversee investments, including real estate ventures.
  • Limitations on Property Use: The investment property cannot be utilized by the individual, family members, business associates, or partners without disqualifying the IRA.
  • Property Expenses: All repairs and expenses related to the property must be paid using IRA funds, which can impact retirement savings.
  • Tax Deduction Exclusions: Despite owning real estate, tax deductions typically associated with property ownership, such as depreciation, property taxes, eligible expenses, and mortgage interest, cannot be claimed.
  • Limited Mortgage Opportunities: Few lenders offer mortgage loans to IRAs, often requiring cash purchases. Inadequate funds to cover substantial expenses may lead to difficulties.

Conclusion: While purchasing real estate with an IRA can diversify your retirement portfolio and boost savings, it is important to carefully navigate the associated financial considerations. Seeking advice from a financial advisor is highly recommended to determine if this investment strategy aligns with your goals and to ensure compliance with regulations. Remember that a comprehensive retirement plan often involves a multi-tiered approach. Utilizing an IRA for real estate investment is just one option among many. SmartAsset’s investment calculator and network of financial advisors can provide additional guidance and insight tailored to your specific financial objectives.