Buying a house with an IRA
You can buy almost anything with your IRA including investment real estate except for collectibles, life insurance, antiques and collectibles, or derivative positions. So, can you buy an investment house, condo, land, duplex, 2-4+ units apartment with your IRA? Most definitely yes. With this knowledge, you are no longer limited to investing your IRA or Roth IRA funds in stocks, bonds and mutual funds like most of us do.
How to buy real estate with an IRA? First you must open and fund a self-directed IRA (you may rollover your existing IRA or Roth IRA to a self-directed IRA or Self-Directed Roth IRA). Once you have a self-directed IRA, you can start owning investment real estate.
Please consult with your tax and legal advisor regarding investing in real estate with your IRA.
Buy Real Estate with a Self Directed IRA
What is a self-directed IRA?
Self-directed IRAs are controlled by you, rather than an account custodian. Banks and brokerage companies, the most typical IRA account custodians, limit your choices to things like certificates of deposit (CDs), mutual funds, stocks, exchange traded funds (ETFs), annuities and other products. But if you want to take control and open up more kinds of investments such as real estate investments, you need a custodian that allows self-directed IRAs.
Converting IRAs to Self-Directed IRAs to buy investment property
Many types of IRAs can be converted to self-directed accounts including Traditional IRAs, Sep IRAs, Roth IRAs, 401(k)s, 403(b)s, Coverdell Education Savings, Qualified Annuities, Profit Sharing Plans, Money Purchase Plans, Government Eligible Deferred Compensation Plans and Keoghs.
Although we focus mainly on real estate IRA investing, self-directed IRAs can also invest in trust deeds, franchises, secured and unsecured notes, limited partnerships, private stock and other nontraditional investments — even wines! You can search online and find dozens of companies that handle these types of alternative IRA investments.
Can you live in the house owned by your IRA?
No. If you live in the house purchased by your IRA, you would incur a tax liability and penalty especially if you are under 59 1/2.
You can not buy your primary residence with your IRA without incurring a taxable liability because the you as the IRA owner cannot benefit directly from the property in any sense, such as by personally receiving rental income or living in the property. You can collect a rental income on your IRA that owns a rental property but the rents must be deposited directly into your self-directed IRA, which grows tax-deferred.
Rules, rules, rules – Buying your retirement home with IRA money
Rules governing these accounts must be followed to the letter or you could find yourself paying very stiff penalties.
For example, you can use your self-directed IRA to buy your future retirement home, but you can’t live in the home until you retire. You also cannot move property that you already own into your IRA. If you purchase an asset like a vacation home for your IRA, you can’t use it for your own personal benefit. This is called self-dealing and could kill all the profit in your IRA.
For example, if an investor took $100,000 from a $1 million IRA to buy land with a rental cabin on it, then took some business partners hunting or fishing on the property, he’d be guilty of self-dealing. The IRS may find out (say he or his partners write off the hunting trip), and then the entire IRA, not just the $100,000 investment in the property, is considered “distributed.” That means if you’re under 59 1/2, the money gets taxed as ordinary income plus a 10% penalty is collected.
Buying a rental property with your IRA
Most people buy income-generating rental property for their IRAs, and some choose to convert a rental to their primary home once they retire. Note: your custodian is a neutral party; it can’t advise you about what property to buy, so you’ll have to do your own due diligence. A skilled real estate agent, attorney and perhaps an accountant or finance pro can help you here. If you want extra help, there are companies that specialize in finding real estate for retirement investing. If you plan to buy and flip properties in your IRA, an IRA LLC (absolutely get an attorney to set this up for you) can facilitate the frequent buying and selling of properties, and even allow you to add and subtract investment partners.
Can you convert a rental or vacation rental property owned by your IRA to your primary residence once you are 59 1/2?
For those who prepare for a specific lifestyle at retirement in advance, some IRA owners purchase a vacation or rental property with their IRA in their desired location and keep them strictly as such (meaning they do not use the vacation rental property for their personal use). Once they reach an age of 59 1/2, many vacation rental IRA owners convert the properties to their own personal primary residence. If the rental property is inside a real estate Roth IRA with after tax contributions, many homeowners with the age of 59 1/2 may not have to pay tax to do this. Otherwise, this conversion would be considered a taxable event. Please consult your tax professional on the tax consequences of converting a rental or vacation rental property owned by your IRA to a primary residence.
A mortgage on the IRA property
If you need to finance your income property, the mortgage must be a non-recourse loan. That means the lender must not be able to go after you and your assets in the event of a default when the sale of the property doesn’t cover the entire outstanding balance. Many states require that mortgages on primary residences be non-recourse; that doesn’t generally apply to mortgages on investment property. You can find such financing by asking mortgage lenders for non-recourse IRA loans. You should understand that the mortgage rates on these loans will likely be higher than current mortgage rates for traditional purchases.
In addition, you can’t use any non-IRA funds to close on the mortgage — it is absolutely illegal to co-mingle any of your non-IRA money with IRA account funds or assets. On the same vein, you cannot personally work on your rental property as your own handyman, plumber or painter to save money. It is safer for you to hire out services and pay for the expenses from your IRA account which holds the real estate.
Note that IRA real estate investments may also generate Unrelated Business Income Tax (UBIT) – learn more here.
Please consult your tax professional for more information.
Downpayment requirement to buy a house with a non-recourse IRA loan in California
Did you know that you can buy a house or investment property with your IRA with around 40% to 50% down payment from your self-directed IRA in California? If you are looking to purchase an investment single family detached, attached home, multi-family townhomes, apartments, condos, and could not pay for the property entirely with cash from your IRA, there are non-recourse lenders in California willing to lend you up to 60% of the value of the property you are purchasing subject to the underwriting guidelines such as the condition of the property, retirement IRA reserves, history of the property, etc. The loan terms are typically amortized over 10,15, 25 years and rates are typically fixed for 3 years, 5 years, 10 years, 15 years, and 20 years. Beware of adjustable rate mortgages — if your mortgage payment makes an unexpected jump, your account could end up short of funds and in trouble. A fixed-rate mortgage is a far safer option when investing for your retirement. There is also a taxable consequence with owning a property with your IRA with a non-recourse IRA loan.
Here are additional examples of prohibited real estate IRA transactions:
- Renting IRA-owned property to family members or a spouse
- Lending IRA cash at a below-market rate to a friend
- Paying yourself from income derived from an IRA investment
- Personally guaranteeing a loan on an IRA asset
To take advantage of the IRA’s tax benefits and avoid costly penalties, you must be sure that there is enough in your account to take care of the expenses that come with owning rental property. Taxes, maintenance, management fees and other expenses must come from funds that are in the IRA. Likewise, all income must stay in the IRA account. Make sure there is enough cash in the account to cover expenses when your tenants move out and have not yet been replaced by new ones. Mortgage lenders generally agree that you should have access to at least six months of expenses for each rental property you own.
Understand the risks
Those with self-directed IRAs can make a lot more money on their investments than those who play it safe. But real estate, as anyone who hasn’t been hiding under a rock during the last three years knows, is far from fool-proof as an investment. If investing in property will tie up the majority of your IRA, you could find yourself dangerously under-diversified.
Credit: This article was published by HSH.com.
To obtain information about investing through a Self-Directed IRA, contact one of the following companies
SELF DIRECTED IRA CUSTODIANS