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The Laurex Process: Client Consultation
Yes, You Can Buy Real Estate within Your IRA
By Trust Administration Services Corporation

Perhaps all your IRA money is in mutual funds and you’d like to diversify. One way is to buy raw land, a house or a building - even your retirement home. The trouble is that you're at least a dozen or more years from retirement and most of your money is tied up in your IRA. If only you could access some of that IRA money without paying a penalty. If only you could rent the real estate and sock away the income, tax-deferred until you retire.

All your IRA money doesn't have to be in paper

Most investors believe they cannot use IRA money to buy real estate. Developed or undeveloped. They are wrong. You can invest IRA money in a wide range of investments, including stocks, bonds, mutual funds, money market funds, saving certificates, U.S. Treasury securities, promissory notes secured by mortgages or deeds of trust, gold coins, limited partnerships and ... real estate. That includes houses, condos, office buildings -- even if located in another country.

You cannot use IRA money to buy your own residence, or any other property in which you live. It has to be investment property. But when you retire, you can direct your IRA to turn it over to you as a distribution, at the current market value.

Let’s take a look at one example

Mr. Client found himself in a potentially disastrous position and was able to free himself using a self-directed IRA. Mr. Client took early retirement from his corporation at age 55 and rolled his company pension plan money into an IRA worth nearly $250,000. The money was invested in stocks and bonds. He then set out to find his dream retirement home.

Within a few months, he found it. It was a bargain price, too, because the owner was required to sell within eight weeks. The contract Mr. Client signed required a $25,000 down payment, to be forfeited if the closing didn’t take place as scheduled. The balance of the purchase price was $150,000.

The problem hit. The investment condo that Mr. Client was going to sell to raise the $150,000 fell victim to a soft market. No buyers. Mr. Client was in danger not only of losing the retirement home of his dreams but his $25,000 down payment as well.

The self-directed IRA to the rescue

The solution was the self-directed IRA. Mr. Client quickly opened a new self-directed IRA, transferred the entire amount of his existing IRA into it, and then directed his new trustee to make the purchase with the IRA becoming owner. The closing took place, but that was only the beginning of Mr. Client’s IRA advantage. Since the closing, the IRA has made wonderful capital improvements in the property and rented it out for a nice income, all tax-deferred. (it may even have been tax-free if the Roth IRA had been in existence at the time.)

Mr. Client eventually sold his personal investment condo and pocketed that profit. Now he is looking forward to his retirement, at which time the IRA will turn the property over to him as a distribution of the then market value.

How come no one knows

Given the real estate boom of the 1980s, and its current resurgence, it’s curious that so little is understood about buying real estate in an IRA. Perhaps it's simply a lack of advertising. IRA accounts invested in stocks, bonds and other financial paper are very lucrative for banks, mutual funds, insurance companies and brokerage houses. These institutions will gladly act as your trustee (the middlemen in all IRAs) and sell you their wares. But they won’t act as your trustee if you want to buy real estate with IRA money. Why? They’re not in the real estate business.

The rules governing buying real estate in IRAs are strict:

  • The house or property must remain in the trust until distribution at retirement.
  • It must be treated like any other investment.
  • You cannot manage the property; however you can hire a third party -- a real estate broker, or local manager -- to collect rents and maintain or improve the property.
  • All rental profits must be returned to the trustee.

You may not be able to mortgage your IRA

The biggest drawback of the buying real estate in an IRA is that it may lack the funds to make a substantial purchase. At present, it is controversial as to whether your IRA can take a mortgage, or if this would violate several IRS provisions and render all of your IRA assets taxable. In addition, it may be difficult to find a lender if you use IRA money as a down payment and take a mortgage for the balance due. To participate in real estate ownership through your IRA even if there is not enough in capital to pay for the entire parcel, you might consider buying only a partial interest in the property through your IRA.

As the self-directed IRA becomes more popular, however, we hopefully will see clarification of the borrowing rules, and perhaps more lenders willing to make loans.

The Roth IRA is an ideal vehicle for those who are eligible. If the value of the real estate is expected to appreciate, it may be to your advantage to opt for a self-directed Roth IRA and pay the taxes now. In that way, so long as the real estate is not distributed for five years, it will incur no tax if the deed is distributed to you personally after attainment of age 59 ½..

Before implementing any significant tax or financial planning strategy, contact you financial advisor, attorney or tax advisor as appropriate.

Article Provided by:

Trust Administration Services Corporation
Feb 1, 2000