Investing in Real Estate Using Your IRA


red house with roof up arrow

With the housing market starting to come off the lows and a lot of money sitting in qualified retirement plans, perhaps you are wondering if you can use your IRA to invest in Sarasota real estate. This article my enlighten you to some investing strategies you may wish to consider if you wish to take advantage of this depressed real estate market for future gain.

During the “good times” a couple years ago, many people took advantage of tax shelters and matching contributions by employers to their retirement accounts. With the stock market recovering nicely this past year perhaps it is time to take a little money off the table and put it into bricks and mortar.

If you want to use money from your employer related qualified plan, you need to request your employer to roll it over (tax-free) directly into your IRA. Then you will need to decide how you want to allocate that money. Before you can purchase real estate with it, you will need to transfer the funds in your IRA to a self-directed IRA.

There are a few things you need to be aware of with a self-managed IRA as some transactions are prohibited. Transactions such as buying stock from a company you own or have interest in for the sole purpose of selling it to sell it back to yourself, or, to lend or borrow money from yourself, or, to invest in interests with “friends” or family members. Logic dictates these are all prohibited IRA investing strategies and transactions when using IRA proceeds.

When investing in real estate, you can only use it to your own advantage when you take an “in-kind” distribution of the real estate held in your IRA for your benefit.

As you are aware, real estate can be a very tax advantageous investment. Investing in real estate for its income and appreciation potential will give you deductions created from the expenses of maintaining the property. Interest payments and depreciation are also fantastic tax breaks. If the deductions exceed the rental income you can use these deductions to offset other investment or employment income.

However, real estate held in an IRA will loose those tax advantages and these investments will have your typical IRA tax characteristics. For a deductible IRA, these characteristics include deductible contributions and tax-deferred growth of its yearly earnings BUT any distributions are subjected to income taxation and for some, this can be quite severe. Once you hit the age of 70 and a half, you must also take minimum retired distributions that you will be paying taxes on.

Roth IRA’s give you tax free yearly earnings and distributions but your contributions to a Roth IRA are taxed as income. This can also be a very expensive initial proposition.

It is very important that you keep in mind that investing in real estate using an IRA, self directed or not, can be a very expensive proposition either going in to the investment, or coming out of it, but there are some strategies and obvious potential for gains that make it worthwhile to jump over a few hurdles.

Here are 3 strategies to consider:

Purchasing Real Estate outside your IRA.

Using distributions from your IRA to purchase real estate will allow you to invest for your benefit, meaning you can use this money to purchase income producing property or a second home. The gains in this market could be substantial and far outweigh the tax liability incurred with the distribution.

Be sure to arrange these investments around deductions you can receive for mortgage interest, depreciation, and other expenses incurred maintaining the property. This allows you to use these tax advantages to offset taxes paid.

Real Estate inside your IRA

If you decide to buy real estate within your self-directed IRA, you can consider using a deductible IRA or a Roth IRA. Remember, you will lose any real estate tax advantages with those investments.

What you are looking for is two big investment benefits of real estate when investing within an IRA:

red jagged up arrow in front of clouds

Higher yearly tax differed earnings (deductible IRA) or tax free (Roth IRA) and high appreciation – that will more than offset the distribution income tax (deductible IRA) or the initial rollover income tax into a Roth IRA.

I would opt for using a Roth IRA rather than the deductible IRA. Although you’re getting hit by a lot of income tax to fund it, you’re presumably buying depressed real estate that will appreciate substantially over years. Also, all rental income and future appreciation is tax free and you’ll never have to worry about making MRD’s at the age of 70 and a half.

When you make an in-kind distribution of your investment real estate that you intend to make available for your use (second home), your bias in it will be equal to the value associated with the income tax you paid for it. (As if you purchased it with employment income rather than investment)

Of course these recommendations are only to spur some thought on your behalf. To fully understand the entire pro’s and cons of investing IRA wealth in this current real estate market should be discussed with a financial advisor competent to give you the best advice for your situation but as an “insider” I see some amazing deals with the potential fantastic gains that could far surpass the initial tax liability the funds to purchase these investments will incur.