By: Brianna Rodgers, Director of Investor Education
Madison Trust is an investor-first Self-Directed IRA custodian offering flat, predictable fees and live guided support for alternative investments.
A Real Estate IRA is a type of Self-Directed IRA (SDIRA) that permits investing in real estate and other alternative assets. While this tool can offer investors many benefits, it also is important for account holders to understand the structure of IRAs to remain IRS-compliant.
Table of Contents
What is a Real Estate IRA?
A Real Estate IRA grants investors the ability to purchase investment properties with their retirement funds. Prospective investors can choose from a wide variety of property types, including:
- Residential properties (single-family and multi-family)
- Commercial real estate (office spaces, storage spaces, storefronts)
- Raw land (farmland, vineyards, undeveloped land)
What Are the Real Estate IRA Pros and Considerations?
Possible Real Estate IRA perks include tax-advantaged growth, retirement portfolio diversification, a potential hedge against inflation, and potential high returns on investment. However, investors must bear certain considerations in mind, such as Real Estate IRA rules, prohibited transactions, and handling property-related expenses correctly.
An In-Depth Look: The Pros of Investing in Real Estate Through an IRA
Retirement Portfolio Diversification
Retirement portfolio diversification is considered a quintessential component of retirement preparation.
Historically, retirement portfolios have relied solely on Wall Street products like stocks, bonds, and mutual funds. Nowadays, incorporating alternative investments like real estate into your nest egg spread is considered best practice as it provides exposure to asset classes that typically perform inversely during stock market fluctuations.
Tax-Advantaged Development
Self-directed accounts allow your earnings to grow in a tax-advantaged environment. As income generated by IRA-owned real estate flows back into your retirement account, your gains can grow:
- Tax-deferred with a Self-Directed Traditional IRA
- Tax-free with a Self-Directed Roth IRA
Autonomy Over Investments
Real Estate IRAs are one of the few retirement plans that let the account holder be the single decision-maker on how their retirement savings are utilized. Instead of depending on brokerage houses or public markets, SDIRAs open the door for investors to implement their own investment strategies. Simultaneously, they can create a retirement portfolio that resembles their interests and possible areas of expertise.
Possible Income Generation
Real estate, particularly rental properties, has the tendency to generate recurring income. With this supplemental cash in your IRA, you can choose to reinvest in other opportunities and initiate even more expansion. This can potentially result in long-term retirement growth, especially as compounding typically occurs.
Considerations Before Investing with a Real Estate IRA
Prohibited Transactions
Performing a prohibited transaction can possibly trigger the loss of your account’s tax-advantaged status. One of the most prominent prohibited transactions is having your account transact with a disqualified person. Disqualified people are:
- You
- Your spouse
- Parents
- Grandparents
- Children
- Business entities owned 50% or more by you or another disqualified person
This indicates that disqualified persons are barred from living on an IRA investment property, or vacationing on an IRA investment property. In addition, no disqualified person or company can perform compensated work on your IRA investment property.
Incoming and Outgoing Money Goes Through the IRA
Any type of expense – or earned income – related to your investment property must be paid directly to your Real Estate IRA.
This pertains to:
- Property taxes
- Repairs
- Maintenance
- Insurance
- Property management fees
- Rent paid by tenants
- Escrow (a common Real Estate IRA mistake)
To ensure a smooth investing journey, an optimal approach is to confirm sufficient funds exist in your IRA to cover ongoing expenses. In tandem, make your tenants aware that all rent checks and wires must be sent directly to your Real Estate IRA.
Acquiring Leverage with a Non-Recourse Loan
Real Estate IRAs can apply for a non-recourse loan, as these loans are designed for Self-Directed IRA compatibility. Nevertheless, employing leverage to purchase an IRA investment property may result in Unrelated Debt-Financed Income (UDFI).
To budget properly, investors may want to understand how financing may affect the overall investment strategy before going forward. Consulting with a financial advisor may prove to be helpful.
Due Diligence is Required
It is the account holder’s job to perform due diligence on all prospective investments. Self-Directed IRA custodians are only responsible for holding your assets and performing transactions at your direction. If hesitant, IRA owners can consider working with outside real estate professionals to get a second opinion.
How Do Real Estate IRA Investments Work?
How Real Estate IRA investments work is relatively simple. To view the general process, visit How to Invest in Real Estate with a Self-Directed IRA.
Once your investment is secured, you’ll be responsible for managing the investment while maintaining IRS compliance.
Real Estate IRA Pros and Considerations FAQs
Yes, a Real Estate IRA can own as many properties as you’d like! As long as each investment property complies with IRS rules and regulations and you have enough funds in your account to handle all expenses, you’re good to go!
