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Should I use an IRA to invest in real estate?

Updated: Dec 7, 2023


Should I use an IRA to invest in real estate?

While traditional and Roth IRAs are generally not designed for direct investment in real estate, there is a self-directed IRA option that allows you to invest in a broader range of assets, including real property. You must set-up a specialized, self-directed IRA account with a custodian that allows for alternative investments. This custodian will handle the administrative duties. You make the investment decisions.


While permissible, should you consider this option a viable addition to your retirement portfolio? It depends.


The major benefits are: (1) Real estate offers diversification from securities with the potential for long-term appreciation; and (2) Rental and capital gain income from real estate held in an IRA can be tax-deferred or tax-free, depending on the type of IRA (Traditional or Roth).


There are rules to follow, such as not personally-benefiting from the property, not using it for personal purposes, and ensuring all expenses and income flow through the IRA

However, before jumping-in, keep these considerations in mind:


  1. Complexity and Regulations. Real estate transactions within an IRA can be more complex than traditional investments and involve strict IRS regulations. There are rules to follow, such as not personally-benefiting from the property, not using it for personal purposes, and ensuring all expenses and income flow through the IRA.

  2. Risks and Challenges. Real estate investments can be illiquid, meaning it might take time to sell a property and access funds if needed. Managing and maintaining real estate properties can be time-consuming and may require additional expertise.

  3. Prohibited Transactions. Engaging in certain prohibited transactions within your self-directed IRA, such as using the property for personal purposes or engaging in transactions with disqualified persons, can result in severe tax consequences.


In my experience, the real-estate self-directed IRA works best for investors who are already in the real-estate business. They know the industry and have an ability to manage the repairs and maintenance in a cost-effective manner.


For the lay investor, I find the tax-deferral or avoidance benefit of using an IRA is not as robust when investing directly in real estate. Given that owners can take depreciation and repairs and maintenance as a deduction against rental income, many rental properties I see do not show a significant profit, as they go. In these cases, the majority of taxable income arrives when the owner sells the property: Property values generally appreciate, and depreciation is recaptured as income resulting in capital gain. However, this capital gain income can also be deferred by using a 1031 exchange or at least partially-avoided if the rental property is inherited by the owner's beneficiaries through a step-up in basis (similar to the tax-deferral or avoidance benefit from the IRA).


Before proceeding, carefully consider your risk tolerance, financial goals, and the specifics of the real estate investment you are considering. If you decide to move forward, it's important to be well-informed and to work closely with professionals who can guide you through the legal and financial aspects of using an IRA for real estate investment.


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