You might have heard by now that it is possible to invest in real estate with an IRA—also known as a Self-Directed IRA. Through this arrangement, you can put money aside for retirement in the form of real estate investments, utilizing the tax protections of IRAs to help serve as an “umbrella” for your portfolio. This is great news to anyone experienced in real estate investing who wants to put aside some of those real estate assets for retirement. It also means that the tax benefits can mean your accounts grow aggressively—especially with a well-timed real estate investment.
But what about the rules? Aren’t they a bit “quirky” and hard to understand? While it is possible to invest in real estate with a Self-Directed IRA, there are some specific rules you will need to keep in mind if you are going to make sure that your investments remain valid. Here is what you will need to know.
Prohibited Transactions in a Self-Directed IRA
Perhaps the most important rules to note are those that regulate “prohibited transactions.” Simply put, you cannot make any transaction you like within a Self-Directed IRA. You can, however, make real estate investments if you do not have any personal connections involved.
What does this mean in practical terms? It means that you would not be able to use a Self-Directed IRA for a personal investment. That means that you would not hold your personal home within a Self-Directed IRA. You would also have to avoid renting out a rental property in a Self-Directed IRA to someone you know, such as a son or daughter. That would mean that you are transacting with a “disqualified person,” and that your investments are benefiting you personally when they are supposed to be there for retirement purposes.
A good rule of thumb is to make investments that do not involve your personal benefit. Yes, it is true that you personally benefit when your retirement account grows larger. But since your retirement account is separate from the rest of your holdings, this will make sense according to retirement regulations. What you do not want is to purchase a rental property and work with someone you know as your tenant. Work through a property manager and rent it out to someone you do not know.
Meeting the Other Retirement Regulations
A Self-Directed IRA is not a “unique” account type. It is still going to fit with the rules of any IRA. For example, if you have a Self-Directed Roth IRA, it is still going to have the properties of a Roth IRA. That means that as you use a Self-Directed account, you will want to keep the following in mind:
- You cannot go over the contribution limit. Self-Direction is not carte blanche to go over the contribution limits with a Self-Directed IRA. You will still be limited with contributions just as you would in any case. But keep in mind that investing in real estate through a Self-Directed IRA can be a great way to grow its value while still adhering to the same contribution limits.
- Depending on the account type, you may have to take RMDs. Required Minimum Distributions are a rule in place so that the government can get its tax money; with a Roth IRA, since you invest with after-tax money, there are no RMDs since that money has already been taxed. But if you invest in real estate with a Self-Directed Traditional IRA, the usual RMD rules will apply.
When you understand the various rules of real estate within a Self-Directed IRA, you will know that they are not so onerous that they make trouble. But you do have to stick to them.