Dear Tax Talk,
How would I go about rolling my IRA into real estate? Can I buy a house and rent it out as an IRA investment?

The IRA would be a down payment on a property. Or, what if the IRA fully purchased the property? I do not intend to live in the house. Thank you.
— David

Dear David,
To answer your question: Yes, you may invest in real estate using a self-directed real estate IRA; however, there are very stringent IRS rules for doing so.

For starters, the property must be rented out full time; it cannot be a personal residence or rented out only occasionally. This automatically prohibits you from taking advantage of the normal deductions related to investment real estate, such as property taxes, mortgage interest or depreciation on your personal tax return.

Additionally, there is a litany of requirements and “prohibited transactions,” including the fact that the IRA owns the property and not you personally. Also, the IRA has to be held under the custody of a fiduciary firm, which means custodial fees will follow. If any prohibited transactions take place, you risk losing the tax-deferred status of your IRA, will owe tax on the full value of the IRA’s assets and, on top of that, if you are under 59 1/2, you will owe a 10% early withdrawal penalty.

What’s a prohibited transaction?

Investment real estate purchased within an IRA cannot be used by the IRA owner at the present time or at any time in the future. It also cannot be leased to “disqualified persons,” which includes the IRA owner’s spouse, parents, children and the children’s spouses.

Source: IRS

It is also difficult, if not nearly impossible, to get a mortgage for property bought within the IRA, so the concept of putting a down payment in the hope that you will generate enough income to pay the mortgage is not a strong option. Expect to pay full price with the assets of the IRA. This can seriously limit the diversification of your retirement assets, which would be ill-advised.

All of this is not to dissuade you, but rather to ensure you are informed that this can be done but requires strict adherence to rather complex IRS rules. And don’t forget that if you invest in the property outside of the IRA, you can likely borrow at a low interest rate, take advantage of the aforementioned deductions for an investment property and benefit from the capital gains rates when you ultimately sell the property.

Thank you for the excellent, timely question — especially since many are now facing rising tax rates and considering more tax shelter options. Happy investing!

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