Use Your IRA for Real Estate Investments

Are stock market woes preventing you from building wealth in your retirement account? If so, you might be interested in a small, but growing, trend among individual retirement account owners-investing their retirement funds in real estate.

A little-known IRS provision lets you extend your real estate purchasing with tax-deferred dollars. Section 408 of the Internal Revenue Code permits individuals to purchase land, commercial property, condominiums, residential property, trust deeds, or real estate contracts with funds held in many common forms of IRAs.

How It Works
If you like the option of using tax-deferred funds to purchase property, you'll need to find an independent IRA custodian that allows real estate investments, and work with that company to set up an IRA account. The IRA account holder can't serve as the custodian of his or her own account. However, it's important to select a custodian knowledgeable about the types of investment you're interested in, because the custodian holds title to the real estate.

Fees, and the flexibility of the services provided, can vary widely among custodians. If the custodian holds real estate on your behalf, but does not service it (collect the rent, etc.), you may have to contract with other providers. However, be sure that all rents are paid into the IRA and that all taxes are paid by the IRA.

Purchasing The Property
IRA custodians that hold real estate will usually allow you to purchase vacant land, residential properties, or commercial buildings for your portfolio. In addition, some custodians may permit foreign property or leveraged property.

Since buying a property may require more funds than you have available in your IRA, you also can have your IRA purchase an interest in the property in conjunction with other investors such as a spouse, business associate or friend.

A Few Limitations

You may not use the real estate owned by your IRA as your residence or vacation home.
Your business may not lease space in your IRA-held property.
You must not have any personal use or benefit of the property.
You may not place a property that you already own into your IRA.
Your spouse, parents or children must not have owned the property before it was purchased by your IRA.

Operating Your IRA-held Property

Because all property expenses, including taxes, insurance, and repairs, must be paid from funds in your IRA, you'll need liquid funds available in your account. Naturally, all income generated from the property will be deposited in your IRA account so you can use that money to cover your costs. You also can make annual contributions within federal guidelines. It's also possible to sell properties while they are held by your IRA, as long as the purchaser is not a family member. Once a deal closes, your IRA account will hold the cash proceeds-ready for you to make your next investment.

You can withdraw real estate from your IRA and use it as a residence or second home when you reach retirement age. At that time, you can elect either to have the IRA sell the property or take an in-kind distribution of the property. Under that arrangement, your IRA custodian assigns the title to the property to you. You will then have to pay income taxes on the current value of the property if it's been held in a traditional IRA. Whether your retirement strategy is to hold properties or buy and sell for gain, real estate investing through your IRA can yield extraordinary returns toward your future retirement.

IRA Options

While any form of IRA allows for real estate investment, there are other considerations when choosing the account type that's best for you:

A traditional IRA lets you deduct annual contributions from your income. However, once you begin withdrawing money, those funds will be taxed as regular income.

A Roth IRA gives you no deduction on your current contributions, but does allow you to withdraw funds tax-free. If you expect to buy a real estate investment in an IRA and hold it for a long period, this is probably your best option, especially if the property increases in value over that period.

A SEP-IRA is designed for self-employed individuals and small companies. Keep in mind that if you have employees, you must make contributions for them as well. This option is a great alternative for real estate practitioners who can make the higher contributions because they can build up funds more rapidly to purchase properties.

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