Global Advice Center

Use an IRA to Invest in Property

Posted on May 19, 2010 07:13:35 PM

Did you know that you can buy investment properties and hold them in your individual retirement account before you retire? Developed or undeveloped, local or foreign–you can use your IRA to invest in real estate without penalty, even if you’re too young to begin taking distributions from the IRA in cash.

IRA funds can be used to buy into an extremely wide variety of investments, including equities (stocks), mutual funds, government and commercial bonds, money market funds, certificates of deposit, U.S. Treasury securities, limited partnerships, promissory notes secured by deeds of trust or mortgages, and, yes, investment property.

What’s more, when it comes to buying real estate with your IRA, your options are hardly limited. You can buy commercial real estate like office buildings, or a condominium, or an apartment complex, or a regular house, or a piece of undeveloped land. The property can even be located in a foreign country.

However, there is one major limitation on what kind of property you can buy with your IRA: it must be an investment. You cannot buy a piece of real estate to live in yourself; it must simply be as an investment. Until you begin taking distributions from your IRA, that is, at which point you can direct your IRA to turn the property over to you as a distribution at its current market value. After you take ownership of the property outside of your IRA (having distributed it at the then-current market value), you can move into it yourself and take up residency there as your retirement home.

As part of the “it must be an investment” requirement, there are strict rules regarding the ownership of real estate within an IRA:

1. It has to remain in the trust until retirement distribution.
2. It has to be treated like any other investment.
3. It cannot be managed by you, the IRA holder. Instead, your trustee can hire a third party like a local landlord or real-estate broker to maintain the property, collect rental fees, and make improvements as desired.
4. All the profits from renting the property out must be returned to the trustee.
5. It is uncertain as of now whether you can take a mortgage out through your IRA for the property. Until the law is clarified, you would be better off assuming that mortgaging an investment property within your IRA is not allowed.

Number 5 above will make it difficult for some people to buy expensive real estate with their self-directed IRAs. However, you can actually pool your IRA funds together with other people in order to purchase property. This is called forming a partnership, and even if you do go through with this, you can always sell your portion of the property and reinvest the proceeds in another property or even another form of investment within your IRA.

What’s more, investment property that earns you money while being held in your IRA is subject to the same tax benefits as any other investment in that IRA. So if you’re using a traditional IRA, the earnings you make from market-value appreciation or renter’s fees are tax-deferred. Or, better yet, if you use a Roth IRA to purchase the property, up to $500,000 of the profits will be completely tax-free (because Roth IRAs are originally funded with already-taxed money).

This makes investment properties an amazingly strong option for allocating your funds within your IRA, and a great way to diversify your savings. By pairing the natural earning power of property investment with the tax-sheltered benefits of an IRA, buying real estate with your retirement fund and holding it there until you take regular distributions is a great way ensure that you get to live out your wildest retirement wishes.