You may have heard about the benefits of investing in real estate with an IRA, and now you’re considering adding real estate to your retirement portfolio. But before you head out to buy that new vacation home or commercial property to start a new business, it’s important to understand how the IRS rules will apply, what to expect for taxes, and how title is held.
Besides knowing the three basics that we will cover in this article; you also need to keep timing in mind. If you have retirement savings and want to invest in a single-family house, commercial property, raw land, or even real estate notes, timing is everything. Establishing a self-directed IRA account early will help you take advantage of real estate investment opportunities when they come up.
Opening a self-directed IRA is easy. You can even do it yourself online. But moving the funds from your existing custodian to your self-directed IRA can take some time. This process is controlled by the previous custodian and of course, no one likes to see a client leave.
Our team talks to real estate IRA investors daily. On average, each IRAR team member has over eight years of experience in the self-directed IRA industry. Empowering your success is what drives them. So, here's what they want real estate investors to know.
Investing in real estate with self-directed IRAs can be extremely beneficial for the investor, but there are rules and regulations that must be carefully reviewed and considered. If you are interested in using or benefitting personally from this investment before you retire, a self-directed IRA may not be for you.
The Internal Revenue Code does not prohibit individuals from establishing a self-directed IRA to invest in real estate as a retirement vehicle. These IRAs allow investors to use their retirement savings to purchase real estate and other alternative assets as part of their retirement planning. It is primarily the SDIRA’s flexibility that makes it attractive to real estate investors. However, it must be for investment purposes only.
This means, for example, if a single-family rental property generates income for the individual retirement account, the payments go to the IRA. Since most of these investments are held long term, the rental income over time will have generated savings that are not taxed until they are withdrawn.
The IRS provides guidance, defining permitted direct and indirect real estate transactions with an IRA. The guidance lists prohibited transactions that apply to all IRA account holders. These include buying or selling property you already own to your IRA, using it as a vacation home, or allowing a relative to be the property manager of the IRA-owned real estate.
A lot of confusion exists about the tax and legal implications of a self-directed IRA real estate investment. Some investors don't use their IRAs to invest in real estate because they are under the impression that the IRA will lose its tax-advantaged status. They fear having to pay the IRS taxes, and maybe even heavy fines.
While some activities within the IRA may affect the tax status of a retirement savings account, like a prohibited transaction, this is certainly not true when investing in real estate for the benefit of growing the IRA.
For example, if you purchased a residential property as part of your IRA, any income generated by the property must go back to the IRA to keep the savings in a tax-deferred or tax-free environment, depending on the IRA type. When you sell the IRA-owned property, there is no capital gains tax because the proceeds go back to the IRA as well.
However, there are certain times when an IRA may create tax obligations. This is because of two IRS rules: Unrelated Business Income Tax (UBIT) and Unrelated Debt-Financed Income (UDFI). This usually happens when the IRA has a non-recourse loan or mortgage payments to a lender, or if the IRA is invested in an operating business.
The IRA must be the title holder of any property you purchase with IRA funds. The property title will read “For the Benefit Of” your IRA. That's what the FBO stands for in the vesting. For example, if the property was purchased outright with IRA funds, the title would be: IRAR Trust Company FBO (your name and your account number).
However, if the IRA partnered or invested through an IRA LLC the title will list all parties in the deal and their allocated investment percentage. For example, here is the title for a property owned by 3 IRAs that all came in with different amounts:
IRAR Trust FBO OwnerName1 ACCT #00001 as to an undivided 11% interest,
IRAR Trust FBO OwnerName2 ACCT #00002 as to an undivided 67% interest, and
IRAR Trust FBO OwnerName3 ACCT #00003 as to an undivided 22% interest
The other important thing to know is that the IRA custodian must sign the sales contract on behalf of the IRA unless you have an IRA LLC.
Before you roll over funds from your Traditional IRA account or make a contribution to your Roth IRA for investments in real estate, it’s important to understand how these accounts work.
Real estate investing with an IRA is for exactly that— investing. It’s not for personal benefit. It may not be what you wanted to hear but we want you to stay on the good side of the IRS. So, follow the rules, be well informed about when taxes apply, and make sure you work with a real estate agent who understands how title is vested.
If you want to diversify your retirement portfolio and invest in real estate with IRA funds, we can help you. As a self-directed real estate IRA custodian, IRAR Trust Company provides investors with the opportunity to build wealth and invest in a wide range of assets including real estate. All investment decisions are yours to make. Call us or schedule a free consultation today.
Disclaimer: IRAR Trust Company is custodian for self-directed retirement plans with expertise in real estate, private placements, LLCs, and other alternative assets. We do not provide custodian services for precious metals, crypto currency, coins, gold, and metals-related assets.