Your Individual Retirement Account can invest in more than stocks and bonds—an IRA also can buy real estate.
But it isn’t as simple as finding a property, investing and moving in. Be prepared to do a good amount of research and financial planning before you start signing papers.
How Buying Property With Your IRA Works
First, you need a self-directed IRA fund. As the name implies, all investment decisions using your IRA are made by you, instead of the IRA holder. But while you make all the decisions, you need a custodian to make investments on your behalf.
Custodians are companies “strictly there to manage the transaction, the paperwork and the reporting,” says Denise Winston, financial expert and author of Money Starts Here! Your Practical Guide to Survive and Thrive in Any Economy.
Custodians will also charge fees related to administrative and reporting purposes, and they don’t give direct advice.
“They may have a seminar, a report or some articles to help you be a better investor, but the deal is the liability relies on us, as a consumer,” Winston clarifies.
You also aren’t limited to buying a house with your self-directed IRA. Some investment examples include these property types:
- Vacant lots
- Parking lots
- Mobile homes
- Multifamily buildings
- Small businesses
- Boat slips
Self-directed IRAs can get tricky, and if you’re not careful, you can wind up in a sticky situation.
For example, don’t expect to live in your property until you retire.
“This is not any kind of personal transaction,” Winston says. “This can’t be a primary, secondary residence or a vacation residence. It strictly has to be a business transaction.”
Neither you nor your immediate family can benefit from the investment before you reach the IRA’s distribution age. If you do, you’ll be slapped with a tax penalty and could have your IRA invalidated.
Everything you use to fund an IRA investment property must come out of your IRA. Likewise, money that comes out of the investment property must be given back to your IRA. So if you buy an apartment and rent it out, that rent money must go back into your IRA—not your wallet.
Similarly, if your investment property requires repairs—like a new water heater—you need to use your IRA to pay for it. If your apartment isn’t rented for months, you’ll still have to use your IRA to pay for the taxes.
“If you don’t have a reserve in there, you have a big problem on your hands,” Winston adds.
A self-directed IRA can be a great choice for some people—provided you’ve done your homework. A rule of thumb from Winston: “Only invest in what you know and you can explain.”
Potential investors should meet with a financial planner, an attorney, or both before investing in a property. Go over all governing rules for the investment and don’t get caught unaware by any applicable taxes or tax implications.
“There are very specific rules, and it’s a very specialized transaction,” Winston says. “Do your due diligence and research before you get too gung-ho.”
When planning, be sure you have enough money in your IRA to cover taxes, emergencies, maintenance and other potential problems. If you don’t, you’ll have to make the maximum annual contribution and hope it’s enough.
“Live ‘as if’ and do it with pen and paper first,” Winston suggests. “Ask, ‘What if this happens? Where would I get the money?’ You’ll quickly see where the gaps are.”