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Many investors don’t realize it’s possible to purchase a variety of assets – including real estate – in individual retirement accounts (IRAs) or other qualified retirement accounts.
As you discover how to use self-directed IRAs for real estate, it’s important to understand the rules – or risk losing potential tax advantages of the account.
Seven Must-Know Self-Directed IRA Real Estate Rules
1. Your IRA cannot purchase property owned by you or a disqualified person.
One of the most common questions about real estate IRAs is: “Can my IRA purchase a property that I currently own?”
The answer is always no.
IRS regulations don’t allow transactions that are considered “self-dealing,” and they don’t allow your self-directed IRA to buy property from or sell property to any disqualified person, including yourself, certain family members, and others.
The IRS lists the following as disqualified individuals: yourself, your beneficiary, your fiduciary, and members of your family (spouse, ancestor, lineal descendant, and any spouse of a lineal descendant).
2. You cannot have “indirect benefits” from property owned by your self-directed IRA.
Can your self-directed IRA purchase a vacation home for you to occasionally use? Can you rent office space for yourself in a building that your self-directed IRA owns?
This real estate IRA rule is in place because the purpose of a Traditional or Roth IRA is to provide for your retirement at some future date. It’s not intended to benefit you (or any other disqualified person) today. If your IRA engages in a prohibited transaction (a transaction that, in some way, benefits you or a disqualified person), this is considered an “indirect benefit.”
The IRS’s prohibited transaction rules list the following other examples of possible violations:
- Borrowing money from your IRA
- Using your IRA as security for a loan
If it is determined you engaged in a prohibited transaction, your IRA will stop being an IRA as of the first day of the year in which the transaction occurred. All assets from the account will be distributed to you and may count as taxable income for that year.
3. You may not perform work on real estate purchased in your IRA.
If you purchase a property with your IRA or other qualified retirement account, can you make updates or rehab the property yourself?
IRS rules note that providing services between a disqualified person and a plan is considered a prohibited transaction. This means that performing work on a property that your IRA owns is not permitted.
As a rule of thumb, it is generally OK to perform “desk work” associated with an investment, but not sweat equity. Consult with your financial or tax professional for guidance on your specific situation.
4. IRA investments are uniquely titled.
You and your IRA are two separate entities. As such the investment needs to be titled in the name of your IRA—not to you personally. All documents related to the investment must be titled correctly to avoid delays.
The correct title for most real estate IRA investments is:
“Equity Trust Company Custodian FBO (for benefit of) [Your Name] IRA”
There are exceptions, such as if your IRA will not own the investment outright.
Learn more about titling your self-directed real-estate investment.
5. Real estate in an IRA can be purchased without 100-percent funding from your IRA.
You can purchase property in more ways than just an outright purchase of the full amount from your account.
Options for funding real estate include:
- Using undivided interest: You could enter into an agreement with other real estate investors to purchase a property, each owning a portion of the property proportionate to the percentage of funds contributed. Your IRA would then receive the same proportion of any profits.
- Partnering with others: You could co-invest your IRA funds with a number of other funding sources, including any combination of your, and/or others’ qualified retirement account or personal funds. (Read more: 6 Ways to Partner your IRA)
- Financing an investment with your IRA: You may use debt financing when you buy real estate in your IRA, as long as the financing is in the form of a non-recourse loan.
FREE Self-Directed IRA Rules Guide
6. IRA investments that use financing must pay UBIT.
If you do obtain a non-recourse loan for your IRA real estate investment, unrelated business income tax (UBIT) applies.
When your IRA buys a property, the IRA is responsible for paying taxes on the profits attributable to the debt-financed percentage. In other words, the percentage of profits subject to taxation is determined by the percentage of the property that is debt-financed.
You are also permitted to write off depreciation and other operating expenses on a percentage basis, which can reduce the amount subject to taxation.
Video: Non-Recourse Loans and Self-Directed IRAs
7. Property expenses must be paid from your IRA – and income must return to your IRA.
One of the final self-directed IRA real estate rules to know involves expenses from the investment property. All expenses related to an investment property owned by your self-directed IRA (maintenance, improvements, property taxes, condo association fees, utility bills, etc.) must be paid from your IRA.
This is done by requesting the funds from your IRA custodian.
Likewise, all rental property income, sale proceeds, or other income generated by a property in your self-directed IRA must be returned to your IRA custodian to be deposited back into your account.
If your IRA partners to make an investment, the proceeds from the investment must return to the account in the same proportion in which the purchase was made.
For example: if your Traditional IRA funded 75 percent of the purchase, 75 percent of the proceeds must go back into that IRA.
If you financed a portion of the purchase with a non-recourse loan, it is possible to write off that proportion of expenses and depreciation on the property on your tax return. Consult your tax professional for more information.