How To Invest In Rental Property Using An IRA

Real estate has proven to be one of the most reliable long term investments, so it's not surprising that many investors make real estate a core part of their retirement planning. But many people are unaware that they can purchase real estate through a self-directed IRA.

What is a Self-Directed IRA?

A self-directed IRA is very similar to any other individual retirement account. It enables individuals to save for their retirement on a tax free or tax deferred basis. Self-directed IRAs offer a way to invest in an extensive range of non-traditional financial assets, including real estate.

How Does a Self-Directed IRA Work?

When investing through a self-directed IRA, the assets need to be held by a qualified trustee custodian. These custodians will provide administrative services including maintaining records of contributions, filing the requisite IRS reports and issuing client statements.

There are a number of restrictions when using an IRA as a vehicle to invest in real estate. One of the most important is that you cannot use your IRA to purchase property from yourself or any other disqualified person. A disqualified person includes the IRA holder's spouse, children, grandchildren and parents.

You also cannot sell a property from the IRA to yourself. This is known as self dealing. In addition you cannot work on the property either for free or by being paid. Any work that is done on the property must be performed by a third party at the current market rate.

Benefits of a Self-Directed IRA

The key benefit of investing in real estate through your IRA is that it is tax deferred and that includes all of the rental income and capital gains. As most people will be in a lower tax bracket upon retirement, this can be very advantageous. Another benefit is the ability to make tax deductible contributions to the IRA.

How to Purchase Real Estate through an IRA

Firstly, you will need to open and fund your IRA. You can fund your IRA using either a rollover, transfer or a contribution. Once you have selected a property you wish to purchase for the IRA you can make an offer, which should be made in the name of the IRA. The earnest money for that property must come out of the IRA or from a non-disqualified person. You cannot use your own personal funds in order to pay for the earnest money.

Borrowing to Invest in Real Estate Using an IRA

You can borrow in order to purchase a property through your IRA. However, any loan used to purchase the property must be a non-recourse loan, which means that the maximum value the lender can recover is the property.

Management of the Property

All of the income that derives from the property must be paid to the IRA or the property management company. All of the expenses for the property must likewise be paid by the IRA. Personal funds cannot be used to meet the expenses of the property. The IRA holder has the right to select the tenants and the management company of the property.

Downsides to Investing in Real Estate through an IRA

Before deciding to invest in real estate through a self-directed IRA, you should be aware of the potential downsides. The work involved with investing in real estate through your IRA should not be underestimated. This involves both setting up the IRA and the ongoing reporting and administrative requirements. As noted above, you also need to be careful in regards to self dealing and meeting the regulatory requirements.

Despite some of the complications that investing through a self-directed IRA can add, with proper planning this can be a highly tax efficient way of investing in the real estate market.

Posted on Nov 22, 2014


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