Exploring the Benefits of Real Estate Investing Through Your IRA
Real estate is a popular investment vehicle for many looking to build a diverse portfolio. While it can offer potential benefits such as appreciation and rental income, investing in real estate through an Individual Retirement Account (IRA) comes with specific rules, considerations, and challenges that should be understood before proceeding.
At Five Buffalo Capital, we know that diversification plays a key role in investment strategies, particularly in retirement planning. This blog explores how to use an IRA to purchase investment real estate, highlight key considerations, and provide insights into the pros and cons of this strategy. Whether you’re an experienced investor or new to self-directed IRAs, understanding how to approach real estate investments within anIRA is crucial.
How Does It Work?
To invest in real estate through an IRA, the first step is to set up a self-directed IRA (SDIRA). Unlike traditional IRAs that are limited to stocks, bonds, and mutual funds, a SDIRA allows an investor to invest in alternative assets such as real estate, private equity, and more. However,not all IRA custodians permit real estate investments, so it’s essential to partner with a custodian who specializes in self-directed accounts.
The IRA-not the individual-legally owns the property. The title is typically held in the name of the IRA account, such as ‘ (Custodian) FBO (Your Name) IRA’. The IRA is managed by a custodian, who facilitates transactions, administrative tasks, and IRS reporting. However, the custodian does not provide investment advice. Their role is limited to ensuring compliance with IRS regulations regarding real estate transactions within the IRA structure.
The Right IRA for Buying Investment Property
Real estate purchases through an IRA are more complex than purchasing stocks or bonds. A SDIRA can hold a variety of real estate assets, including single-family homes, apartment buildings, commercial real estate, or undeveloped land. All assets must be for investment purposes only and not for personal use.
Because the property is held by the IRA, not the individual, the individual cannot benefit personally from it during the holding period. All income and expenses related to the property must flow through the IRA account.
Rules and Regulations for Using an IRA to Buy Real Estate
Investing in real estate through a SDIRA offers flexibility, but it also comes with strict rules. Violating these regulations could result in penalties or disqualification of a SDIRA, which could lead to significant tax consequences. Below are some of the most important rules to keep in mind:
No Personal Use: Any property held within a SDIRA cannot be used for personal purposes. This includes vacation homes, second homes, or using the property as an office for a business that benefits the individual. The property must be used strictly for investment purposes. If the investor or any disqualified person (spouse, children, parents, etc.) use the property, it may be considered "self-dealing," which is a prohibited transaction and the IRA could become disqualified and lose its tax-advantaged status.
No Transactions with Disqualified Persons: The IRS defines certain individuals as "disqualified persons," which include family members (spouse, parents, children) and entities owned by these individuals. The investor cannot buy,sell, or lease property to or from these disqualified persons.
No Personal Financing: While it's possible to use non-recourse loans in a self-directed IRA, most transactions are made in cash due to complexity and UBIT (unrelated business income tax) implications.
IRA Pays All Expenses: All property-related expenses, such as maintenance, repairs, taxes and property management fees, must be paid from the IRA. The investor cannot pay for these expenses out-of-pocket.
Required Minimum Distributions (RMDs): Once the investor reaches age 73, they must begin taking Required Minimum Distributions (RMDs) from your IRA. This may include selling properties, taking in-kind distributions (e.g., a partial property title) or distributing rental income to fulfill the RMD requirement.
Pros of Buying Real Estate with Your IRA
There are several advantages to holding investment real estate within an IRA, particularly for those looking to diversify their portfolios and incorporate alternative assets. Some of the key benefits include:
Diversification: Real estate adds a non-correlated asset to a retirement portfolio.
Potential for Appreciation: Real estate may appreciate over time, enhancing long-term returns.
Tax Advantaged Growth: Gains within a traditional IRA grow tax-deffered, and within a Roth IRA, potentially tax-free.
Rental Income: Income flows directly back into the IRA and grows tax-deferred until distribution provided it is distributed at age 73 or later.
Cons of Buying Real Estate with Your IRA
While there are clear benefits, there are also some notable drawbacks and risks to consider when investing in real estate through an IRA:
High Initial Cash Requirement:Without traditional financing, the IRA must cover the full purchase cost.
Liquidity Concerns: Real estate is not easily liquidated, which may complicate RMDs or reallocation strategies.
Expense Management: Owning real estate comes with ongoing costs, including maintenance, repairs, and property management. If significant expenses arise, these costs must be covered by the IRA. The investor cannot pay for these expenses personally without penalties.
Complexity and Compliance Risk: The rules surrounding real estate transactions within an IRA are complex. Violating these rules could lead to tax penalties or disqualification of the IRA.
Market Risk: Real estate markets can be volatile, and property values can fluctuate based on economic conditions, interest rates, and local market trends.
Tips for Successful Real Estate Investing with Your IRA
If an investor chooses to invest in real estate through an IRA, it's important to proceed with caution and take certain steps to help ensure success:
Research Thoroughly: Complete due diligence before purchasing any property. Understand the local market, the property’s potential for rental income, resident demand, market supply, property conditions, and the associated costs.
Work withProfessionals: Engage custodians, tax advisors, and real estate sponsors who specialize in SDIRAs. Diversify: Consider spreading real estate investments across different property types (residential, commercial) and locations to reduce risk.
Stay Informed About IRS Rules: The IRS has strict rules governing self-directed IRAs. Stay familiarized with IRS guidelines and avoid transactions involving disqualified persons.
Frequently Asked Questions (FAQs)
1. Can I Finance Real Estate with a Self-Directed IRA?
Yes, an investor may use a non-recourse loan, but it’s complex and may trigger unrelated business income tax (UBIT). Most investors choose to purchase with cash from the IRA.
2. Who Owns the Property in a Self-Directed IRA?
The IRA owns the property, titled in the name of the IRA custodian for the investor’s benefit.
3. Can I Build a House With My Self-Directed IRA?
Construction may be allowed if managed correctly through the IRA, but the investor cannot perform the work or engage disqualified persons. There are compliance rules to follow to ensure this is not a self dealing activity. Most custodians do not allow speculative development due to compliance risks.
4. What Happens if I Don’t Follow the Rules?
If an investor violates the IRS rules related to self-dealing or improper property use, the IRA could be disqualified, which would result in significant tax consequences.
5. How Do I Sell Real Estate Held in My IRA?
To sell real estate in an IRA, contact the custodian, who will handle the transaction on behalf of the account. The proceeds from the sale will be deposited back into the IRA.
6. Can I Rent the Property to My Family?
No. The investor cannot lease the property to themselves, spouses, children, parents, or other disqualified persons.
The Bottom Line
Investing in real estate through an IRA offers certain advantages, such as diversification and the potential for tax-advantaged growth, but it also comes with several challenges. The complexity of the rules, the illiquidity of real estate, and the high initial cash requirements are all factors to consider before moving forward.
At Five Buffalo Capital, we offer accredited investors passive investment opportunities in multifamily assets that may be suitable for retirement accounts such as SDIRAs. Our team will work closely with financial advisors and custodians to support investors using SDIRAs to gain exposure to diversified real estate portfolios—without the burden of direct ownership. Our data-driven acquisition strategy targets properties in growth markets with strong fundamentals and value-add potential.
Accredited investors may schedule a call with our investment team to learn how Five Buffalo Capital's multifamily fund offering may integrate into your retirement strategy using a self-directed IRA.
Important Information-Blogs are intended to be educational and rely on information from sources deemed to be reliable. Nothing in this blog contains legal, tax, financial, or any other type of advice. All investors should consult their own financial, tax, legal, and other professional advisors to determine if an investment is suitable for their unique situation.
*All investments have risk. Please view our disclosures.
https://www.fivebuffalocapital.com/disclosures
