When you work in real estate long enough, you will come across transactions in which the buyer or seller wants to use an IRA to complete the deal. This is especially true if you’re working with commercial properties, or ones that may be rented out or flipped. Read on to find out what you need to know about this investment tool in real estate transactions.
What is an IRA real estate transaction?
Using an IRA to invest in real estate, rather than buying or selling as an individual, is one way to generate retirement funds that are either tax-free are tax-deferred. Self-directed IRAs, as opposed to those run by an employer, allow the holder to diversify beyond traditional assets like mutual funds, stocks or bonds. Real estate is one of the assets that the IRS allows, along with oil and gas holdings and precious metals. However, the IRA must be administered by a qualified custodian—either a financial company that specializes in this, or a special limited liability company that the IRA holder sets up to manage it.
How do IRA transactions work?
If you’re dealing with an IRA buying or selling a property, there are a lot of restrictions you’ll need to know about. The IRA’s beneficiary cannot also be the buyer or seller of the property, and all funds involved in the transaction must come from the IRA, not the beneficiary. The property must be held strictly as an investment, and the IRA beneficiary cannot interact with the property in any way or receive any direct benefit such as rental income from the property. This means that even something as small as mowing the lawn can cross the line as far as the IRS is concerned. Penalties are strict—any violations will terminate the IRA retroactive to the first day of the year in which the violation occurred. This is why a lot of people buying with IRAs pay third-party property management companies to take care of repairs and maintenance.
What steps are involved?
If an IRA is the buyer of a property:
- The IRA custodian or administrator must execute all documents, including the purchase agreement.
- Plan documents confirming the identity of the custodian or administrator and stating that the IRA is authorized to purchase real property are required.
- Vesting will be [Name of Custodian] as custodian for [IRA account number], in the name of [Beneficiary].
If an IRA is the seller of a property:
- The IRA custodian or administrator must sign all documents.
- Plan documents confirming the identity of the custodian or administrator and stating that the IRA is authorized to purchase real property are required.
- All proceeds must be paid to the IRA, not the beneficiary.
- Any liens or judgments against the IRA’s beneficiary must be shown and satisfied.
In general, there may be additional requirements depending on the specific transaction, but this list sums up the basic ones.
Should you buy or sell using an IRA?
Because IRAs allow the holder to save for retirement either tax-free or tax-deferred, any income generated by an IRA’s real estate holdings will not be taxable. That means that if your IRA buys a house for $200,000 and sells it for $250,000, the IRA made $50,000 of tax-deferred money. But, there are also a number of risks involved, especially if you’re planning on funding your retirement with real estate investments. The inherent fluctuation of real estate values can potentially put your nest egg at risk. Plus, homes and buildings tend to have a lot of maintenance and upkeep costs associated with them. If you’re planning on using an IRA to buy or sell, make sure you do your research on the property first, and talk to a tax professional or financial adviser to ensure you understand the details of self-directed IRAs.
