Real estate alternative investments are an increasingly popular element of diverse retirement portfolios. For some investors, it can make sense to include real estate in a retirement portfolio by holding the property in a self-directed IRA.

While the rules governing real estate held in IRAs can be strict, there are a number of benefits to keeping real estate in an IRA:

  • Real estate can be used to generate rental income, and rents can be raised over time to keep pace with the market. Likewise, rising prices can increase the resale value of real estate. That real estate income has tax-advantaged growth potential of its own when held in an IRA.

  • Real estate income in Traditional IRAs is not taxed until the assets are withdrawn. Assets withdrawn from Roth IRAs are tax-free.

  • Real estate investments are typically not correlated with fixed-income or equity investments, and can provide a hedge against inflation.

Here’s what you need to know about using real estate as an IRA investment and the rules for investing.

What types of real estate can investors buy in a self-directed IRA?

Self-directed IRAs can be used to hold a wide range of real estate investments, including raw land, single- and multi-family rental properties, commercial properties, private funds and real estate development companies.

What are the rules for investing?

The idea with any asset in a self-directed IRA is that the account is earmarked for your retirement. As such, there are rules to keep you from accessing any current benefit from the real estate asset.

To ensure that a real estate IRA remains qualified and its assets stay tax-deferred, IRS rules restrict certain transactions:

  • No personal use or use by certain relatives. Although the IRA is in your name, and the property within the account is for your ultimate retirement benefit, you can’t receive any current direct or indirect benefit from any asset held in your IRA. In terms of the property, you can’t live in it, vacation in it, use it or get any indirect benefits from it, like payment for managing it—and neither can any “disqualified person” as defined by the IRS.

  • Investors can’t work on the property. You must pay an independent person to maintain and repair it.

  • Investors can’t use a mortgage to purchase the property. Non-recourse loans (in which a lender’s only recourse for non-payment is recovery of the collateralized asset used to secure the loan), however, are allowed.

  • The IRA must pay all expenses related to the property. Investors must be sure there are enough funds held in the IRA to cover potential major capital expenditures as well as ordinary maintenance costs and property taxes. Don’t pay expenses with your personal funds.

    You have three (3) options when it comes to payments of ordinary real estate maintenance costs:

    1. Millennium Trust Prepaid PEXTM Debit Card – the card is loaded with funds from your IRA and can then be used to pay for expenses related to the IRA property, such as miscellaneous repairs or maintenance expenses.
    2. Check Request – complete the Real Estate Expense Payment Direction form and Millennium Trust will cut the check for the expense. Note: the form will need to be completed each time you need a check cut.
    3. Third-Party Manager – if you choose to use a third-party manager, Millennium Trust will need the Rental Income Information form and you will need to ensure a separate property management account is set up by the property manager for the retirement account.

  • If the property operates at a loss, investors cannot claim the losses on their tax return, nor can they claim any depreciation.

  • Investors who hold real estate in traditional IRAs must take required minimum distributions (RMDs) beginning at age 70½ and should make sure the IRA holds sufficient liquid assets, beyond the value of any real estate held within it, to cover those withdrawals.

How does the investment process work?

Work with experienced professionals to help you choose the right property:

  • Realtors can help identify investment properties.

  • Lenders can help with non-recourse loans.

  • Financial advisors and accountants can prepare a cash flow analysis to help predict the potential return on investment.

Select a knowledgeable service provider:

  • Investors should use a custodian that specializes in the custody and administration of non-publicly traded investments, such as real estate, to handle real estate transactions within an IRA.

  • The custodian can help set up the right accounts when you’re ready and will also report deposits, withdrawals and balances to the IRS.

An experienced custodian can help streamline the process of investing in real estate in a self-directed IRA as investors work to build a diversified multi-asset portfolio to help achieve financial goals.

For additional information, see IRC Section 4975 and Millennium’s Guide to Holding Real Estate in Your Retirement Account.

Millennium Trust Company performs the duties of a directed custodian, and as such does not sell investments or provide investment, legal or tax advice.