A common question that Rent to Retirement gets asked by our investors is “Can I use my IRA/retirement to purchase a real estate investment property?”
The answer is, YES! Many people are interested in finding loopholes with their money in order to purchase real estate. Sometimes coming up with the cash on hand is difficult. So we try to educate our clients on other ways to make their real estate investing journey happen sooner for them. The sooner you invest, the sooner you start building wealth!
What is an IRA?
An IRA, or an individual retirement account, is an account used for saving and investing money for retirement that has tax advantages. There are several types of IRA accounts that people can look into based off of the assets they are looking to acquire. The main one that I would like to focus on today is a self-directed IRA. The reason this type of account is of importance is because it will allow the IRA account holder to purchase an investment property with their funds. As IRA’s are commonly known for holding stocks, bonds, mutual funds and things in the like, a self-directed individual retirement account will also allow the holding of real estate investments.
Purchasing real estate with your retirement funds comes with many rules that need to be followed carefully. The tax advantages of using a self-directed IRA account are great, unless prohibited transactions take place. This could result in the taxing of your entire retirement account. That would be a large tax bill! One of the biggest rules to follow is that the property you purchase, must be for investment purposes only. You are not allowed to occupy the
property or use it as a business or a vacation home at any time. So this property must be, what is called, an arm’s length transaction. This means it cannot benefit you, your family or any entity that owns more than 50% of the property.
If there are any repairs that are needed on the property, all funds to replace or fix items must come from your SDIRA. You must also hire a third-party company to do the repairs. Putting in personal sweat equity on the home is not allowed. You must also hire a custodian to manage your SDIRA. This person will handle all of the
reporting on deposits, withdrawals, and year end balances. A custodian will not give any financial advice. Your SDIRA is exactly as it sounds; yours to self-direct. You make all of the important decisions as to where your money goes as well as being responsible for knowing all of the rules of using one of these retirement accounts.
How to Purchase Real Estate with an IRA
It is important to note that the account holder of the IRA and the IRA in itself, are two separate entities. The IRA actually owns the property, the account holder does not. When the property is purchased, the title will be vested as follows: [IRA Company] FBO [Account Holders Name], Account # 123456. You will not take title on the purchase of the investment property. Any rent paid by the tenant will go directly back to the IRA. It will not directly into your pocket, making it inaccessible until you are allowed to withdrawal at the age of 59 ½ with no tax penalties. Another important point to make is that there are many different ways to purchase a property with your IRA.
These include using cash from your account, non-recourse financing, using an LLC, or purchasing as a partnership as tenants in common. Most commonly used, is cash, as the benefit from this would be no monthly payment to anyone on a loan and higher, immediate returns. This may not be the best method for you if the account doesn’t have enough funds or the account holder is just starting their retirement account. An account holder is allowed to roll over funds from other retirement accounts. This allows them to pay cash for the investment property if they have enough money built up. If the funds are not available, non-recourse financing is your next best option.
Taking out a mortgage when purchasing real estate with an IRA is not an option. So that brings us to non-recourse lending. Using this type of financing means that if for some reason, you as the home owner stopped making payments on the loan, the lender would not be able to go after any other assets other than the home that the loan is for. This makes it a much higher risk for the lender making the interest payments higher and the down payments around 40-50%. So the IRA holder is not liable and the loan is made out to the IRA company. Keep in mind that the
property being purchased can be single family, multi family, commercial and even undeveloped land. So this leaves the IRA holder many options to choose from to diversify their portfolio.
Pros & Cons
PROS: Tax benefits! On a normal real estate transaction, whatever gains are received are taxed. When using a SDIRA, taxes are delayed and your contributions can grow tax-deferred. Roth SDIRAs contributions can be withdrawn tax-free when you retire.
RE investments are safe in your SDIRA. Funds in SDIRA are protected from creditors.
Compared to traditional stocks, bonds, and mutual funds, real estate has a higher ROI.
CONS: Can’t claim deductions, depreciation or loss on these investment properties.
Lack of liquidity.
Can’t ever occupy the property in any way.
Several regulations and possible disqualification.
The Next Step
If you are interested in other ways to build up your retirement and include real estate, this is a great option. This is another great example of a way to start investing in your future now, rather than waiting until you have all of the cash in a savings account to make the jump. Start building wealth, today! Take a look at our Inventory List or get in contact with us to schedule a free consultation!