Guest post by: Rick Pendykoski
When it comes to IRAs, you can divert from the usual investment vehicles are stocks, bonds, and mutual funds or exchange-traded funds (ETFs) and invest in real estate, including homes, apartments, commercial properties, or land with your IRA.
In this article, we’ll talk about the two options of using IRA to fund your real estate purchase.
There are two options to invest in real estate with IRA:
- Using a self-directed IRA
- Borrowing against your traditional and ROTH IRA
1. Using a Self-Directed IRA to Buy Real Estate
A Self-Directed IRA permits real estate investments through an IRA custodian.To make these investments, you need to find a custodian that allows self-directed accounts. Your IRA custodian will maintain your account records and ensure that you comply with IRS requirements.
If you own a traditional IRA, you can convert it to a self-directed IRA, by finding a new custodian (if necessary) and transferring the account. You can convert Roth IRAs,SEP IRAs, 403(b)s, 401(k)s, etc. to self-directed accounts.
Can you use that property? Who are “disqualified?”
Your real estate property bought with your self-directed IRA funds should be purely for investment purposes. You cannot live in it, use it as a vacation home, office for your business or a place for your kids to live. The IRS imposes these rules on you and the people it considers as disqualified. So, let’s understand who these disqualified people are. They include your spouse, parents, grandparents, great-grandparents, children, their spouses, grandchildren and great-grandchildren. The service providers of your IRA and any entity that owns more than 50% of your property are also considered as disqualified people.
Additionally, you can’t buy the property from any of the disqualified people. This transaction is considered self-dealing.
Pros and Cons of Property in an IRA
- Appreciates over time
- Helps in diversifying your portfolio
- Provides a steady rental income (if property on rent), which grows tax-free within the IRA
- Allows you to buy, sell, flip, and accumulate properties
- You need a custodian to set up a self-directed IRA.
- All your property-related expenses, including repairs, and maintenance costs have to be paid with IRA funds.
- You and the disqualified people cannot live or operate the property business. You need to hire people to run or manage the property.
- You can’t claim deductions for property taxes, mortgage interest, depreciation and other property-related expenses.
2. IRA Loans: Borrowing Against Your Traditional and Roth IRA
Technically speaking, you cannot borrow from your IRA or take IRA loan directly. You can, however, use the “60-day rollover rule” to borrow money from your IRA to make a real estate investment. Essentially, money borrowed against your IRA can be deposited back into another qualified tax-advantaged account without taxes and penalties, if deposited within 60 days.
Ways You Can Borrow From Your IRA Without Attracting a Penalty
- If your age is 59½ or above, you can take a distribution from your traditional IRA without attracting any penalty. But, you’ll attract income tax when pulling out the money since the original contributions were tax-deductible.
- However, if you have a Roth IRA, contributions and earnings can be taken out without paying the penalty or tax if you have had the Roth IRA for 5 years or more and your age is 59½ or above. However, if you take out the earnings early, a 10% penalty will be charged on the amount you withdrew.
- You can use the 60-day rollover rule to your advantage. The IRS allows you to rollover money from one IRA to another or withdraw it from your IRA as long as you deposit it back in the same IRA within 60 days. If you follow this 60-day rollover rule, you don’t need to pay any tax or penalty.
When Should You Borrow Against Your IRA?
If you can avoid withdrawing from your IRA, do that. If you have a financial emergency or a time-bound investment opportunity, you can take advantage of the 60-day rollover period. However, it may make sense to explore other funding avenues, such as taking a loan on margin against stocks in your investment portfolio, making a tax-free withdrawal from the initial investment in a Roth IRA, and take interest-free loans from friends or family. If you are taking advantage of 60-day rollover period, consider potential setbacks such as paperwork delay and public holidays.
Rick Pendykoski is the owner of Self Directed Retirement Plans LLC, a retirement planning firm based in Goodyear, AZ. He has over three decades of experience working with investments and retirement planning, and over the last 10 years has turned his focus to self-directed accounts and alternative investments. Rick regularly posts helpful tips and articles on his blog at SD Retirement as well as Business.com, SAP, MoneyForLunch, Biggerpocket, SocialMediaToday and NuWireInvestor. If you need help and guidance with traditional or alternative investments, email firstname.lastname@example.org.