Purchasing a Property in Your IRA? Consider This First

So you want to be a real estate investor, and you think you’ve found just the right property to start with. But before committing to the investment, it’s important to take a step back and fully assess the situation to ensure that you are prepared for all possible outcomes of investing in real estate in your IRA, including the good, bad, and possibly ugly.

The decisions you make with your retirement funds may have implications not only for your future, but also for your children or grandchildren if you plan on making them your beneficiaries.

When I began self-directed investing, it took years to learn the ins and outs of these accounts, their tax-advantages, and strategies for utilizing them to build wealth. Now, there is so much information at investors’ fingertips. Still, each investor must make sound and well-informed investment decisions to reap the benefits.

So how can you determine if you’re ready to purchase a property in your IRA? What questions should you consider before making the commitment?

5 Questions to Ask Before Purchasing Real Estate

1. Have I vetted the property, sellers, or potential partners?

A major part of self-directed investing is performing your own due diligence when necessary.

Vetting the individuals or companies involved in the investment is the only way to make sure that “perfect” opportunity or property is all it’s cracked up to be. Building location, its attractiveness to renters or sellers, the conditions of the property, and your future plans with it are major factors in thinking about the investment long term. If you’re partnering with someone else or with another company on this investment, it is important to consider their potential long term reliability, quality of work, and trustworthiness.

Whenever I am making a real estate investment, I make sure to look at the demographics of the property and its location. I try to think ahead and ask if these demographics match my exit strategy or my buy and hold strategies. When dealing with partners, I consider what they are bringing to the relationship. A partner’s strengths should compliment your weaknesses and augment your strengths, and likewise, your own strengths should do the same for your partner.

The example I often use when evaluating potential investment partners is: “Time, treasure, talent”. Older people who have other jobs such as doctors doing operations or mailmen with routes every day have money from their income, but they don’t necessarily have the time to devote to an investment. On the other side of the equation is a young kid with the energy who has the time and knowledge to do the work, but not lacks the money. By combining the time, money (or treasure), and knowledge/talent of these two investors, you create a strong working relationship.

Like studying for a major exam, you’ll do your best, and feel your best, when you are most confident about knowing your stuff. For the sake of your peace of mind, going into an investment with as much confidence as you can, and knowing it backward and forward, will be key.

2. Can my IRA maintain this property?

Because your IRA is a separate entity from you, it is responsible for all ownership and maintenance costs. If the property should need repairs, or if renters move on and leave the property vacant for several months, your IRA has to be prepared to pay for those costs and cover those losses. You personally cannot pay to keep the property afloat should a situation like this arise, and you are limited in your cash contributions, depending on the type of account you have and your age. If your IRA cannot rise to these challenges, then it may be time to step back and re-evaluate your investment.

The great thing about investing in real estate with your IRA is that the IRA gets the income, but it also has to pay the expenses. The SECURE Act changes will allow you to make contributions to your IRA as long as you have earned income, but in my experience, I have seen people pursue other routes if they aren’t earning income. In situations in which your IRA would need more money to maintain a property or properties, your IRA can take a loan, but it has to look at where it would infuse capital. If your IRA has money you can transfer from another IRA, you can borrow from a bank, or you can borrow from an individual, but these all must be non-recourse loans. You also have the option to bring in a partnership to share ownership of a property between your IRA and the partner if your IRA is in a hole.

3. How far along am I in my retirement journey?

Is retirement just around the corner, on the horizon, or far off your radar? No matter where you are in the retirement planning process, taking stock of your retirement’s readiness before making an investment is another imperative step you should take.

As I mentioned in a recent blog post, “Pros and Cons of Tax Advantaged Plans,” different rules apply for Traditional and Roth IRAs. When it comes time to retire, the types of assets you have in each type of account will matter. For example, with a Traditional account, once you turn 72 (unless you turned 70 ½ prior to December 31, 2019) you need to begin taking your required minimum distribution. If you have real estate in your Traditional IRA, it will be difficult to sell a property off in pieces every year in order to take your RMD. If you’re close to retirement age, perhaps investing in a different asset class is a better fit for you. When this is the case, consider converting your assets to those that offer more liquidity. However, if you’re just beginning your savings for retirement, owning one or more properties to buy, sell, and hold in your IRA could be the perfect move for growing your retirement funds.

For an example of this idea in action, we'll take a look at my mother. She is 87, and let’s say she owns a house in her IRA that is worth $500,000. Her IRA earns $50,000 in rent, but with taxes, insurance, and maintenance costs, she nests $34,000. That’s not enough to make her RMD of $37,000. In this situation, in order to be able to continue holding that property in her IRA, she should have a Roth IRA instead of a Traditional. This way, she does not have to take her RMD. With a Traditional account, she would have been better off converting that house to a more liquid asset to better prepare for taking her RMDs.

4. Is this transaction allowable in my IRA?

In terms of real estate, your IRA cannot purchase a property owned by you or any disqualified persons. You cannot benefit indirectly from the property. For example, you cannot rent out office space owned by your IRA or purchase a vacation home with your IRA and live in it over the summer. Your contractor spouse cannot make repairs on a property you would like to flip in your IRA, however, their father’s construction company can. The property must be vested/titled in the name of your IRA, not you personally. All income and payments have to flow directly through your IRA.

Prohibited transactions can result in costly penalties to your IRA. Therefore, when you’re sizing up the property that you want to hold in your IRA, fix up, and sell, it’s important to consider not only the credibility of those you are investing with, but how their contribution and service will affect your IRA. So before you unknowingly risk your tax-advantaged status with a potentially bad character, do your homework and make sure your investment story checks out.

For more information on prohibited transactions to avoid in your IRA, check out, “A Guide for Avoiding Prohibited Transactions in Your Self-Directed IRA.”

5. Am I ready to commit to this investment?

Real estate can be a beneficial investment to help actively build your wealth and diversify your portfolio, but if you’re not ready or equipped with the tools to make such an investment, you can experience detrimental effects that your IRA may not be able to handle. Through a combination of detailed research, substantial margins for error, and checking in with your advisers to avoid prohibited transactions, you can prepare yourself for any oncoming hurdles you’ll need to jump.

With these questions in mind, asking yourself if you’re ready to make this particular type of investment is perhaps the greatest question you can ask when making a major commitment to a real estate investment. If the answer is yes, then congratulations on your IRA’S new purchase. If not, don’t be discouraged. There are resources available to you, whether it’s online, at in-person meet ups, or through building your network on platforms like BiggerPockets, you can work as much as you feel you have to in order to gain the knowledge you are seeking. By acquiring the valued information you will need to make an investment, you can prepare yourself for any outcome that comes in the way of your investment. Once you feel like you’re ready, confident, and equipped with the knowledge you need, you can proceed with your investment and begin growing your retirement funds through this lucrative asset.

Have more questions about an upcoming real estate investment that’s on your radar? Comment below!