Investing in real estate with an IRA, 401(k) or other retirement plan can be a powerful way for you to diversify your retirement portfolio. With social security dwindling, investors may look into hard assets so their retirement funds are not only reliant on the performance of publicly-traded securities.

IRAs and other retirement plans offer unique tax advantages on the returns of the investments held within the accounts. These tax advantages are why you may choose to use your IRA for your next property investment.

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Retirement plans have specific rules outlined by the IRS which govern the way you can interact with your IRA investments. Violation of these rules can result in a fine and/or forced distribution of your investment property from your account.

If you’re a real estate investor looking to put your expertise to work for your retirement savings, you’ll want to understand the IRS laws that regulate your investment before you buy in.

The following 5 rules are things every IRA owner should know before investing in real estate.

1. You cannot “indirectly benefit” from your IRA investment property

Because your IRA property is meant to be used once you reach retirement age (59.5 years of age, according to the IRS), you and any other disqualified persons can’t live in or use the property until you, the IRA owner, reach 59.5. Failure to recognize this rule can result in a fine and/or the early distribution of your property from your IRA.

At any time, you can rent your IRA property to any non-disqualified persons to receive rental income.

A disqualified person who cannot indirectly benefit from your IRA rental property includes but is not limited to:

  • You
  • Your spouse
  • Your ascendants (parents, grandparents, etc.)
  • Your direct descendants (children)
  • Your direct descendants’ spouses
  • Certain fiduciaries (CPAs, attorneys, financial planners, etc.)
  • Other IRAs or entities owned by a disqualified person

2. Beware of Prohibited Transactions

Illegal interactions between your IRA rental property and a disqualified person are called “prohibited transactions.” Prohibited transactions can result in a fine and/or early distribution of your property from the account.

The IRS defines prohibited transactions between your IRA property and a disqualified person, as such:

  • Buying from or selling an asset to the retirement plan
  • Living in or renting any property owned by the retirement plan
  • Personally using the retirement plan’s asset (for example, living in or renting out an IRA’s property)
  • Using personal finances to pay an IRA asset’s expenses
  • Handling money related to any IRA asset
  • Making improvements to an IRA asset (for example, cannot personally work on an IRA’s real estate property)
  • Taking a commission on the purchase/sale of the IRA’s assets

3. All expenses and rental income must stay within the IRA

It’s important to think of your retirement account like a separate entity from yourself. You may be the account owner, but your personal funds can never be used to pay any expenses your IRA property may accrue.

This includes, for example, paying to fix the roof or laying new carpet. This also includes paying property taxes and HOA fees.

In the same vein, any return your IRA property makes on rent must stay within the IRA account until you reach the IRS designated age of distribution for your asset.

4. IRA investments that use financing must pay UBIT

If your retirement plan doesn’t have the funds to cover the full purchase price of an investment property, your IRA can purchase real estate using a non-recourse loan.

If you use debt-financing, you will have to pay unrelated business income tax (UBIT) on the percentage of profits that are attributed to the debt-leverage. More on calculating UBIT.

5. You can partner your IRA with other funds to purchase real estate

Just as you can use a non-recourse loan to help fund your IRA’s real estate investment, you can also partner your IRA funds with other funds to cover the purchase price. In this instance, your IRA can even partner with disqualified persons — such as your own personal funds, your other IRA accounts or the personal funds or IRA accounts of family members — to buy the investment property.

To avoid prohibited transactions after your purchase the IRA property, just remember: An IRA can partner with anyone at the time of the property purchase, but after the transaction is complete, the IRA cannot conduct any business with a disqualified person.

IRA rules can sometimes be tricky, so be sure to consult your financial advisor or attorney before buying your investment property. From proper titling to avoiding missteps, your legal team is here to make sure your IRA investment follows the rules so it can grow and support your future retirement.

Contact us to help you navigate your next IRA real estate investment and stay off the IRS’ radar.

Contact Rogers & Moss for your free, no-risk, consultation.