Rental Property: A Popular Alternative Investment in Self-Directed IRAs

Real estate is the number one investment used by self-directed IRAs to build retirement income. There are many different assets that fall into this class including: rehab-and-flips, tax liens and certificates, foreign land, commercial property, and rental property. With a self-directed account, the owner has control over his or her retirement funds and investing decisions and has the ability to choose any one (or all) of these assets to build a nest egg for the future.

Investments in rental property offer the potential for investors to earn continuous tax-sheltered income in their accounts. The right piece of property in a good location can garner an attractive return that is often higher than income gained using mutual funds, bonds, or CDs, and a bit more secure than stock market options.

How Does Rental Property Work in a Self-Directed IRA?

There are a few things investors need to be aware of when using rentals to secure retirement funds. Committing a prohibited transaction or dealing with a disqualified person can have disastrous results in the form of heavy penalties and/or taxation. An IRA can even lose its tax-sheltered status if it does not operate in compliance with IRS rules and regulations as specified in in IRC Section 4975.

Buying and Selling Property

First things first: Understand that your IRA is making this purchase with funds available in that account, which means the title will be in the retirement plan’s name and will not be in your own name. This property can be used for investing purposes only. As the account owner, you are unable to live in this property, and you can’t vacation in it, either. Plainly put, you are unable to receive any personal benefit from any investment in your retirement plan until the age at which you retire.

As the account owner, you are able to choose the property, but there are restrictions as to whom you may purchase it from. You cannot purchase a property that you currently own, or one that is owned by another disqualified person or entity. Other than yourself, disqualified persons include your spouse, lineal descendants (children, grandchildren), and lineal ascendants (parents, grandparents). Your IRA is not allowed to perform transactions with anyone who provides service to the account, or any entity in which disqualified persons have a 50 percent or greater interest.

For the same reasons, your IRA is unable to sell its asset(s) to the aforementioned parties, as well.

However, if your account does not have adequate funds to purchase an asset, it has the option to partner funds with another individual or entity. Your IRA can partner with your personal funds, or those of your spouse or daughter, etc. You can even partner funds with those of another IRA or business to invest. The income and expenses gained and incurred by the asset are split depending on the percentage of ownership by each person/entity. So, if your IRA owns 50 percent of the asset, it receives only 50 percent of the income and pays only 50 percent of expenses associated with the investment.

Income and Expenses for Rental Property in an IRA

Rentals come in several different forms. Common investments include commercial property, which can be leased out to businesses or single and multi-family homes that are rented to individuals or families. These assets gain income through the monthly payments of rent, agreed upon by both parties when a space is leased. All income is deposited directly into the IRA where it grows on a tax-deferred or tax-free basis, depending on the type of retirement plan you have.

All expenses (upkeep, maintenance, etc.) must be paid with IRA funds. When purchasing an asset for retirement planning purposes, make sure the account holds enough money after the acquisition to pay any expenses the property may incur in the future. You are not allowed to pay for anything with your personal funds. You are also not allowed to perform maintenance on the property yourself—these transactions must be performed by a qualified, third party person or business. Additionally, unless the property is purchased using an LLC in an IRA, you are unable to act as property manager; the IRA must hire a third party to take on that responsibility if necessary.

When you self-direct your retirement funds, you get to make your own investing choices. You also take on the responsibility of performing due diligence to ensure the assets you choose are viable. This helps in identifying fraudulent transactions you want to steer clear of and increases your chances of securing an adequate return on your investment.

Get Started Self-Directing Your IRA Today

To find out more about rental property in an IRA or to learn more about self-direction and the many different investments permissible in these accounts, contact us for a free consulation.