Should Retirees Consider Real Estate Investing With Their IRA Money
© Shane Flait (2011) 

Yes, you can buy real estate with your IRA money. And retirees often have a lot of IRA money and are wondering how they can use it for real estate investing. This article overviews the advantages and disadvantages of real estate with IRAs.

 

Why retirees – or near retirees- may want to buy real estate with IRA money

By the time they approach retirement, many people have accumulated a lot of money in their qualified plans such as a 401(k) or an IRA. It’s IRA money that’s burning a whole in their pockets. They wonder how they can best use this money for real estate investing.

 

Their reasons for getting into real estate are varied; they include:

·         buy a condominium and duplex to enjoy and possible rent out a helpful investment

·         buy a house they can rent out and eventually move into or leave as a legacy to a child

·         buying real estate as an assured source of retirement income  

 

But tax implications have enormous consequences on buying, holding and selling real estate.

 

Real estate: its benefits, costs and tax breaks for owners

Owning real estate brings two benefits. It can supply you a rental income or, if you live in it, save you rental payments to someone else. Secondly, real estate values generally increase over the long term. It’s a reliable investment if the owner can keep up the payments for it through hard times.

 

But real estate carries two significant expenses. Those are mortgage interest payments since few can buy a house outright, and an annual real estate tax levied by your town.  

 

The government gives you some great tax breaks on these benefits and expenses that help you own real estate. When you sell your property, you’re taxed at the low long term capital gains rates. And if you’ve made it your own home, you can exclude up to $250,000 of gain if you’re single- and twice that if married. That’s huge!

 

Whether or not you rent your property out for rental income, the government allows you to deduct those major expenses of mortgage interest and property tax against any income your have. But if you receive rental income, you can also deduct depreciation, annual maintenance expenses, and fees associates with renting it. All those deductions often shelter not only the rental income it generates but other income too.

These tax breaks are extremely advantageous. But let’s see what happens to these benefits and tax breaks if you hold your real estate within your IRA account.

IRA tax characteristics and restrictions on real estate holdings within an IRA account

The first restriction is that you can buy real estate within your IRA only if it’s a self-directed IRA. So you’ll need a trustee or custodian assigned to your self-directed IRA. Additionally, you and relatives are prohibited the use as well as the buying or selling of any real estate holding in your IRA. So you can’t live in it while it’s within your IRA account.

IRAs are governed by their own tax rules. These wipe out the general tax characteristics of any property they hold – and that includes all those tax benefits associated with real estate given above.  That’s an extremely important point for those considering real estate investments.

IRA taxes follow two sets of tax rules depending on whether they are a deductible contribution qualified plan (like the traditional IRA) or the non-deductible contribution qualified plan (like  the Roth IRA). Traditional IRA allows you a tax deduction in the year of your contribution from working income. All those IRA investments will grow tax-deferred until you make a withdrawal after your 59½ when you’ll pay income tax on whatever you withdraw. That’s a high tax rate especially if you withdraw a lot in a single year. And, you must make minimum required distributions (MRDs) after you turn 70½.

Roth IRAs, though, allow only non-deductible contributions. Their key benefit is their investments grow tax-free and any withdrawals come out tax free also. They don’t require any MRDs for the Roth IRA owner.     

Approach to real estate investing and IRA accounts

Recognizing both normal real estate taxation benefits and IRA tax rules for IRA investments, retirees should consider investing in real estate with either of two approaches:

1.      Buy and grow your real estate within a Roth IRA – not a traditional IRA, or

2.      Buy your real estate  with sequential yearly withdrawals from a traditional IRA 

 

Your Roth IRA gives you tax-free rental income to use and can distribute your property to you tax free too.  Your real estate owned outside your IRA helps minimize withdrawal taxation from your traditional IRA. So, use the two tax systems only if they complement each other for you.