Are you thinking of investing in real estate, but wonder where you’ll get the money? If you have retirement funds set aside (in an IRA), you may be able to use them to purchase an investment property. Retirement funds aren’t restricted to the standard investments, like stocks and bonds; real estate can be a very plausible option as well.
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How it Works
The biggest thing you need to know about using your retirement funds to purchase an investment property is that you cannot use any personal funds to buy the property. This would violate the IRS rules and could trigger costly penalties and taxes on your withdrawal.
When you purchase an investment property with your retirement funds, every dollar that goes into the home must come from retirement funds. This includes the money to purchase the home, pay the taxes, and maintain/repair the home. The same is true for any gains you make on the property. If you buy the property for say $200,000 and sell it for $350,000, the gains go right back into your IRA.
You will have to appoint a custodian to handle the process for you as well. This does cost money, but it reduces the risk of any conflict of interest occurring. The custodian handles the purchase and/or sale, as well as any paperwork. The custodian oversees the project to make sure that you don’t violate any IRS rules.
If you don’t have enough funds in your retirement account to purchase the investment property outright, you may be able to get a mortgage. It must be a non-recourse loan, though. In other words, the only thing that the lender could go after if you were to default on the loan is the home. They could not go after your IRA fund. This type of mortgage is hard to find, so finding a property you can pay for entirely through your IRA is probably your best bet.
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What You Can’t Do
It’s important to note what you cannot do with the property that you purchase with your IRA. Under no circumstances can you use the property for your personal use. This means you cannot use it as a primary home, secondary home, or vacation home.
In addition to you being unable to personally use the property, neither can anyone that you have an arm’s length relationship with including:
- Parents
- Grandparents
- Siblings
- Children
- Anyone in connection with your IRA
Also, you are unable to purchase the property from any of the people above. Again, you must have an ‘arm’s length’ relationship with the seller in order to purchase the property entirely with your IRA.
How it Affects Your Taxes
Unlike when you buy a home with a mortgage and/or your personal funds, you cannot deduct any of the expenses tied to the investment home on your taxes. This is because the income you earn is tax-deferred. If you sell the home, as we said above, the money goes right into your IRA. This means you don’t pay taxes on the capital gains. The only time you’ll pay taxes on the funds is when you withdraw them to use them during retirement.
It’s important to know that you’ll need to be able to sell the property before you hit the required age that you must take IRA distributions. Right now, this age is 70 ½. If you don’t have enough cash in your IRA to cover the required distributions, it could leave you in trouble with the IRS. That’s why it’s important only for experienced real estate investors to take advantage of the opportunity to buy an investment property with IRA funds.
