IRAs and Real Estate

Posted: 18 May 2008 | Categories: Investing

IRAs and Real Estate

Who hasn’t heard the word diversification when talking about building an investment portfolio? Everyone knows just how important it is to spread your potential risk across a variety of investments, but few people are aware that you can invest in real estate using money from certain individual accounts, know as self-directed IRAs.

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Similar to other IRAs in every respect, self-directed IRAs differ in one crucial way. They allow account holders to take charge of their own investments. That means you can buy and sell investment real estate for your benefit while deferring possible tax consequences.According to the IRS, retirement money can be used to buy real estate in any form: houses, condos, office buildings, etc. For instance, let us say you find an apartment complex in foreclosure for an excellent price. You can purchase the building with funds from your IRA and either sell it for a profit or become a landlord and earn income (rent checks) that will be directed into your IRA. Improvements and renovations can also be done to the property using funds from the IRA. When you finally decide to sell the property, those proceeds would go back into your IRA, where it would continue to grow tax-deferred.

Under current law, you are allowed to buy, sell and even use rental properties in your self-directed IRA. In our example of buying a foreclosed apartment complex and collecting rents, all associated maintenance and renovations costs, taxes, property management fees and insurance must be paid, as mentioned, from the IRA, and all rental income must go back into the IRA. Here is the nice part. The rental income generated from the apartment complex becomes part of your IRA balance which can be used to buy other types of investments. This includes such investments as certificates of deposit, stocks, mutual funds, treasury securities and even precious metals such as gold and silver.

Another nice aspect of a self-directed IRA is that, if handled correctly, you may be able to use this money to invest in a property for your retirement. One often used approach is to use the property as a rental until you retire, then take a distribution of the property from the IRA at the current market value and pay whatever tax is due prior to moving in. It is a great way for many investors wanting to buy a second-home.

Self-directed IRAs have specific rules that must be adhered to so it is important to consult an accountant or financial adviser familiar with how these investment vehicles work and can correctly set up and manage them. Here are a few key things to remember when using a self-directed IRA for real estate investment purposes:

All income from the investment property must go into the retirement account and all expenses associated with it must be paid from the account.
The purchase of real estate must be for investment purposes.
You can not purchase property with your self-directed IRA that you personally own.
You must ensure that the property to be acquired is not a prohibited transaction (i.e. you can not have the property owned by your parents, children, spouses or a corporation in which you own 50 percent or more.)
You and your family members can not live or rent the property while it is in your IRA account.

Using a self-directed IRA to invest in real estate opens up a whole new realm of possibilities for investors who are interested in real estate and particularly buying and selling foreclosures. As with any investment vehicle, be sure to do your homework. These accounts must be set up correctly and adhere strictly to the IRS prescribed rules and regulations. Talk to a qualified expert about what option may work best for you and your particular investment goals.

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