Real Estate IRA
Section 408 of the Internal Revenue Code permits individuals to purchase real estate in an IRA including land, commercial property, condominiums, residential property, mortgages, trust deeds, real estate contracts or private placements. You can use funds held in many common forms of IRA’s, including 401k’s, a traditional IRA, a Roth IRA , and a Simplified Employee Pension plan, or SEP-IRA.
There are two ways to purchase real estate using an IRA:
- Directly in the custodial account – the custodian holds title to the property, receives the income and pays the expenses. All subject to ongoing transaction fees.
- Using a Self Directed IRA LLC – The LLC holds title to the property. You as Manager of the LLC can receive the income and pay the expenses.
Purchasing the Property
Most IRA Custodians that hold real estate will usually allow you to purchase raw or vacant land, residential properties, or commercial buildings for your portfolio. In addition, some custodians may permit foreign property or leveraged property.
Since buying a property may require more funds than you currently have available in your IRA, you also can have your IRA purchase an interest in the property in conjunction with other individuals, such as a spouse, business associate, or friend. Also keep in mind that if the property is leveraged, the debt must be a non-recourse promissory note.
Unfortunately, Internal Revenue Service regulations will not let you use the real estate owned by your IRA as your residence or vacation home. Nor can your business lease space in your IRA-held property. The underlying premise for any real estate investment purchased with IRA funds is that you can’t have any personal use or benefit of the property. To do so may cost you plenty in taxes and penalties.
There are a few other IRS limitations as well. You cannot place a real estate property that you already own into your IRA. Your spouse, your parents, or your children also could not have owned the property before it was purchased by your IRA. Property owned by siblings may be allowed, since the Internal Revenue Code (section 4975) specifies that only “lineal descendents” (i.e. Mother, Father, Son, Daughter or their spouses) be disqualified.
Once you’ve chosen a property:
If buying directly in the custodial account…your IRA custodian—not you personally—must actually purchase the property. The title will reflect the name of your IRA custodian for your benefit (such as XYZ Trust Company, Custodian FBO John Doe IRA). In addition, if you put up earnest money with your personal funds, you’ll need to make sure you include that amount in the total due so that the title company can reimburse you upon closing.
If you have a Self Directed IRA LLC – the purchase will be made and title to the property will be in the name of the LLC, not in the name of the custodian, and you as Manager of the LLC can purchase the property, sign all offers and contracts, manage the property, collect the rents and pay the expenses from your LLC checking account…all without custodian approval and ith no transaction fees from the custodian.
Because all property expenses, including taxes, insurance, and repairs, must be paid from funds in your Self Directed IRA LLC, you’ll need liquid funds available in your account. Of course, all income generated from the property will be deposited in your Self Directed IRA LLC bank account so you can use that money to cover your costs.
If you do not have sufficient funds in your IRA to purchase the property for cash and need to get a mortgage to purchase the property it must be a non-recourse mortgage. A non-recourse mortgage is a mortgage that you do not personally guarantee. You cannot personally guarantee a mortgage on property owned by your IRA.
It’s also possible to sell properties while they are held by your Self Directed IRA LLC, so long as the purchaser is not a family member. Once a deal closes, your Self Directed IRA LLC account now holds the cash proceeds from the sale of the property—ready for you to make your next investment. An alternative is to sell the property with seller financing so that all payments including interest payments made by the buyers are paid to your Self Directed IRA LLC all tax deferred until you start taking distributions from your IRA!
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