What are the Tax Rules and Advantages of a Real Estate IRA?

Whether you’re looking to take advantage of the real estate market, want to diversify your retirement savings, or don’t trust the stock market but want to take advantage of the tax benefits of an IRA, a real estate IRA might be for you. There are several differences in how a real estate IRA and brokerage IRA work, so it’s important to do your homework before diving in. This post explains who investing in real estate in your IRA can benefit you and the rules you need to be aware of to do it right.

This post is provided for general information only. Please confirm the details and circumstances of your unique situation with your tax accountant or other appropriate advisor before taking action.

Real Estate IRA Overview

You might think that there are just traditional IRAs and Roth IRAs. Maybe you’re familiar with SEP IRAs and SIMPLE IRAs if you own or work for a small business. What you never hear about is bond IRAs or stock IRAs. So why is real estate different?

What is a real estate IRA?

A real estate IRA (REIRA) gets its name from what you hold inside of it. It’s similar to other types of IRAs, except that instead of holding stocks, bonds, mutual funds, you hold real estate or real property.

The IRS defines real estate as “real property.” Real property includes houses, apartments, commercial buildings, land, and undeveloped lots. It also includes things like personal residences, rental properties, vacation homes, and second homes.

Is real estate allowed in an IRA?

Real estate is technically allowed in an IRA. However, you can’t buy real estate directly within the more popular brokerage IRA accounts. Since a brokerage has to register with the SEC, they’re limited in what kinds of investments they can offer. This will usually be stocks, bonds, ETFs, mutual funds, bank CDs, and similar investments.

There are two ways to buy real estate in an IRA. If you’re using a brokerage IRA, you can buy a REIT. REIT stands for Real Estate Investment Trust. A REIT invests in many different types of properties and sometimes other businesses related to the real estate industry. You can buy REITs as individual stocks or baskets of REITs in ETFs or mutual funds.

A REIT is not the same thing as owning individual properties. It has different investment characteristics and passive income potential. If you want to own individual properties, you need to get a self-directed IRA.

How do I set up a real estate IRA?

Setting up a real estate IRA or self-directed IRA requires a lot of paperwork. When you have a brokerage IRA, the brokerage submits information to the IRS like your contributions, withdrawals, and current account value. This makes sure you’re taking proper deductions, paying tax on withdrawals, and not improperly moving money in and out of your retirement account. With a self-directed IRA, the IRS still needs that information, but there’s no brokerage to do it for you.

The best way to set up a real estate IRA is with a self-directed IRA provider like Rocket Dollar. Self-directed IRA providers help you do the paperwork to set up an IRS-compliant IRA and meet your ongoing reporting requirements. If you want, you can also hold other types of alternative assets like cryptocurrency.

Is real estate a good investment?

Many people see real estate as a good investment opportunity. Real estate may not be suitable for every retirement portfolio. You may want to talk to a financial advisor if you’re unsure what’s right for your retirement plan.

What are the tax advantages of a real estate IRA?

There are several tax advantages to using any type of IRA, including a self-directed IRA.

  • You can hold any type of investment, including real estate properties, without taking money out of your IRA.
  • You can choose a Roth or traditional self-directed IRA.
  • With a traditional self-directed IRA, you can deduct your contributions on your income tax return. You don’t pay taxes until you withdraw your money in retirement.
  • With a Roth self-directed IRA, you deposit after-tax money. The advantage is that you get tax-free growth. There are no taxes when you withdraw your money in retirement.
  • You don’t pay taxes on sales, dividends, or other income inside of an IRA. If you sell one property and buy another, you don’t have to worry about capital gains taxes or trying to do a Section 1031 exchange. If you receive rental income, it isn’t taxable income, either — it stays in your IRA just like dividends from a stock in a brokerage IRA.
  • You can roll over your traditional IRA or 40k to a self-directed IRA. There are no immediate tax savings, but it lets you move your money into different types of investments without paying the taxes and penalties for taking it out of your retirement account.
  • You can convert a traditional IRA to a Roth IRA. If you think your tax rate will be higher in the future, a Roth conversion lets you lock in your tax rate today. When you do a Roth conversion, you pay your ordinary income tax rates now just like a traditional IRA withdrawal. There are no penalties, and the money then grows tax-free in your Roth IRA just like other Roth contributions.

What are the real estate IRA rules you need to know?

Not knowing the real estate IRA tax rules can disqualify your IRA and subject you to substantial penalties and possible back taxes. One of the benefits of using a self-directed IRA provider like Rocket Dollar is that they help you follow the rules. It’s also a good idea to find a tax advisor who can help you with the finer points of investing in real estate inside of your IRA.

How much money can you put in a self-directed IRA?

The current limit on IRA contributions is $6,000 per year. You can contribute an extra $1,000 catch-up contribution if you’re age 50 or older. Income limits apply. The annual contributions limits are across all your IRA accounts not per account.

Traditional IRA Income Limits

Filing Status202220212020
Single and Head of Household$68,000 to $78,000$66,000 to $76,000$65,000 to $75,000
Married Filing Jointly and Qualifying Widower$109,000 to $129,000$105,000 to $125,000$104,000 to $124,000
Married Filing Separately$1 to $9,999$1 to $9,999$1 to $9,999
If your income is up to the lower number, you can make a full contribution. Your contribution drops to $0 once you reach the second number.

Roth IRA Income Limits

Filing Status202220212020
Single and Head of Household$129,000 to $144,000$125,000 to $140,000$124,000 to $139,000
Married Filing Jointly and Qualifying Widower$204,000 to $214,000$198,000 to $208,000$196,000 to $206,000
Married Filing Separately$1 to $9,999$1 to $9,999$1 to $9,999
If your income is up to the lower number, you can make a full contribution. Your contribution drops to $0 once you reach the second number.

If you want to contribute more and have qualifying business or self-employment income, you can set up a self-directed solo 401k.

If you want to move money from another IRA account, there is no limit on what you can roll over or convert. If you convert a large amount, make sure you have a plan to pay the taxes. You can’t use IRA funds to pay the taxes unless you count it as a withdrawal that may be subject to early withdrawal penalties.

Can I live in a property owned by my self-directed IRA?

No, you can’t live in a property owned by your IRA. You also can’t let family members live in that property either for free or if you charge them the market rent. You have to have a true investment property. If you choose to rent the property out, it has to be an arms-length transaction with an unrelated renter.

What type of real estate can I hold in an IRA?

You can hold almost any type of real estate. This includes single-family homes, duplexes, apartment buildings, commercial properties, and more. You can also invest in tax liens or flip houses in a self-directed IRA.

Do I have to report transactions inside of my IRA?

You generally don’t have to report when you buy or sell property or get a new renter. However, you should keep detailed records in case of a tax audit. Since this involves an IRA, keep your records permanently in case there are issues when you go to withdraw money in retirement.

Can I withdraw from my IRA to invest in real estate?

The advantage of a self-directed IRA is that you don’t have to withdraw from your IRA to buy real estate. You can hold cash in your self-directed IRA and buy real estate in the same IRA.

If you want to buy a house to live in or other property that doesn’t qualify to be in an IRA, the normal withdrawal rules apply. If you’re before retirement age, you may have to pay taxes and early withdrawal penalties. You may be able to avoid penalties if you qualify as a first-time homebuyer. In addition, Roth IRA contributions can also be withdrawn tax-free.

Can you use self-directed IRA funds towards a down payment for a rental property?

First, see the question above. If you’re asking whether you can use your cash balance as a down payment and get a mortgage to buy a property in your IRA, the answer is yes. The type of mortgage you need is a special mortgage called a non-recourse loan. Under the tax law, you can’t be personally liable for the mortgage beyond your IRA assets. The lender holds the property as collateral and can also pursue your IRA assets if necessary. Loans to IRAs carry a lot of risk for lenders, so they aren’t easily available and carry much higher interest rates than traditional mortgages.

Can I sell my property to an LLC that I own to take advantage of US capital gains tax laws?

 You can’t buy or sell property to yourself in an IRA. This is known as self-dealing.

The following transactions are also prohibited under self-dealing:

  • With your family members
  • With an entity (Limited Liability Company, trust, other business) that you or a family member owns more than 50% of.
  • With an entity that you own 10% or more of, are a highly compensated employee of, or are a directed or board member of.
  • With your IRA provider or their fiduciaries.

Can you sell an investment property and roll the proceeds into a self-directed IRA to delay paying taxes on the gain?

 A sale outside of an IRA can’t be rolled into an IRA to avoid capital gains taxes. A sale within an IRA doesn’t need to be rolled over. You can keep the funds in your IRA for a later purchase.

Can you invest in a friend’s real estate fund via an IRA vehicle?

In most cases, a friend is not a disqualified person, and you can invest in their real estate fund if it’s properly set up. Whether this is a good idea from an investment standpoint is a different question.

 What is a Real Estate IRA Custodian?

A self-directed IRA provider is also known as a custodian. Unlike a traditional IRA custodian, they don’t hold your investments. Instead, they only hold your paperwork. You hold your investments separately.

Who can be a custodian for a self-directed IRA?

An IRA custodian must be a bank, credit union, trust company, or licensed non-bank custodian. Non-bank custodians are licensed and regulated by the IRS. You can’t act as your own custodian or use a family member.

What are some things to consider when choosing a company to handle your self-directed IRA for real estate investing?

There are many companies out there offering services related to self-directed IRAs. Some offer better customer service, others provide lower fees. There isn’t one right choice among all of them. It depends on what features you value most. Here are some things to look at when choosing a custodian:

  • Customer Service: How responsive are they to questions and concerns? Do they have a phone number where you can call with questions? Are they willing to help you find answers to common problems? Do they have a live chat feature? Can you reach someone who speaks English well?
  • Fees: What are the fees charged per year? Is there a minimum fee? Will the costs increase each year?
  • Trustee/Trustees: Who will manage your money? Do they have experience managing large amounts of money? Do they have any conflicts of interest?
  • Compliance: Does the company comply with federal regulations? Have they been audited recently?
  • Insurance: Do they insure against theft, fire, natural disasters, etc.?

Who is the best self-directed IRA custodian for real estate?

Who is best for your self-directed IRA will depend on your specific needs. One company to consider is Rocket Dollar. Rocket Dollar allows you to easily set up a self-directed IRA or solo 401k at an affordable price. In addition to real estate, you can hold cryptocurrency, start-up companies, gold, and other alternative investments. Click here to see more benefits, view the pricing plans, and create your account.

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