Although many people do not realize it, you are allowed to hold real estate – as well as real estate back instruments like REITs or Deeds of Trust – inside your Individual Retirement Arrangement (IRA). The reason many people do not understand this is because many IRA trustees – the firms that are authorized to offer IRAs by the Internal Revenue Service (IRS) – choose not to allow their clients to hold real estate assets because they are more difficult to administrate than basic securities (like cash, stocks, and bonds). Further, people with full service IRAs – where they turn their investment decisions over to experts – are also frequently never informed that their IRA can hold real estate since few professional IRA administrators consider this a viable financial investment in of itself.
Nevertheless, with just a little shopping around it is fairly easy to find an IRA trustee that will accept real estate investments in their IRAs. Generally speaking, these IRAs are self-directed, meaning that the IRA owner is responsible for his or her investment decisions, including real estate. Further, at least some IRA trustees may charge additional administration fees in order to hold real estate investments since they are usually more difficult to administrate within an IRA, difficult and time consuming to have registered as needed and virtually impossible to liquidate unlike most securities. Therefore, if one decides to use their IRA to hold real estate, one should expect to pay a bit more than would otherwise be the case.
The primary advantage to buying real estate through an IRA is the tax deferment; therefore this technique is only really applicable to Traditional IRAs, which allow the owner to deduct their contributions and do not have to pay taxes on the property inside the IRA until they reach the age – fifty-nine and half – where distributions become mandatory. Though full taxes owed on the property will be due at some point, if the real estate purchase is done as part of a well designed investment strategy, once the property has to be distributed arrangements should be made to cover the relevant tax bill.
Although IRA holders are not allowed to buy a home that they reside in through the IRA – as only investment property can be held – an intended retirement property can be bought in advance through the IRA. The idea being that once the IRA owner retires, he or she can have the real estate distributed from the IRA directly into their personal possession. Needless to say, this means the taxes for this large distribution will be due in that year, nevertheless if the real estate was handled properly beforehand this should not represent too much of a problem. One of the most popular ways of handling this is to rent out the property in question for years before distributing it. The rent money also goes into the IRA and then be transferred to a Roth and then can later be used to pay a lot of the taxes due on the primary real estate distribution. There are other ways of structuring this as well, so it is worth talking to your financial advisor and developing a comprehensive plan before buying real estate through your IRA.