Buying real estate through your IRA is a lucrative and competitive business. It can substantially increase the return on your IRA’s investment, and make for a big, cushiony retirement nest egg. One of the biggest reasons that more people don’t take advantage of owning a real estate IRA is all the rules and confusion that comes along with it. It can be a meticulous task, but well worth it.
Self-Directed Real Estate IRA
Although IRS rules permit IRA funds to be invested in real estate, IRS rules do not require an IRA trustee to offer real estate as an investment option. Most trustees who offer traditional IRA investments, such as depository banks, do not allow an IRA owner to invest in real estate because of the extra administrative burden of real estate management. As a result, if you want to invest your IRA funds in real estate, you will most likely have to convert your traditional IRA to a self-directed IRA, which is an IRA that requires you to decide what investments to make, such as real estate.
IRS rules require the IRA-owned real estate to be for investment purposes only. This requirement places several prohibitions on how the real estate can be purchased and used, the key to understanding the prohibitions is the term “disqualified persons”. This term is used in the IRS rules regarding IRA-owned real estate to refer to the IRA owner and related persons–that is, the IRA owner and spouse, ancestors (mother, father, grandparents) and descendants (children, grandchildren, and their spouses). The term disqualified person also includes the IRAs investment advisers, including a trustee of the IRA funds, and any business in which a disqualified person has a 50 percent or greater interest. IRS rules prohibit the use of IRA funds to purchase real estate from a disqualified person, the rules also prohibit a disqualified person from using any real estate IRA purchased with IRA funds, either as a home or business. These rules even preclude you from purchasing a vacation home that is only partly for personal use and otherwise rented to others.
If you violate the IRS rules regarding prohibited transactions, the IRS will consider the IRA funds used in the transaction as a distribution of your IRA. You will be taxed on the funds from the first year in which the transaction occurred, with penalties and interest included. Depending on your age, you may also incur an additional penalty for taking an early distribution.