It’s true: investors can invest in real estate with a retirement account, and they can do so with a Self-Directed IRA. This enables many investors who make wise investment choices to diversify out of the stock market, add stable rental income to a retirement portfolio, and potentially build plenty of wealth for the long term. However, although Self-Directed IRAs may be popular among real estate investors, it doesn’t mean that such accounts are without their limits. It’s important for any investor to better understand what those limits are. Here are some of the key limits to which you will want to pay close attention.
Why There are Investment Limits with a Self-Directed Real Estate IRA
For many people, real estate transactions can often occur with people they know. Perhaps they rent out a room to a brother or a sister. Perhaps they assist with someone’s loan. It’s not really a stretch to imagine that investors want to continue this behavior even if they are using a Real Estate IRA. However, when working within a retirement account, the rules change.
Think of it this way: a retirement account should be a separate entity from your personal investments. That means that if you were to rent out a real estate property to someone like a son or a daughter, you would get the immediate benefit from helping out a family member—something that a retirement account is not designed for. A retirement account is designed to protect the returns and gains on long-term growth, expressly for the purposes of using that money after you have hit retirement age. For that reason, the IRS does not want investors using Self-Directed IRAs for short-term deals that can potentially benefit the investor in the near-term. Otherwise, the Self-Directed IRA simply becomes a vehicle for realizing tax protections while squeezing short-term personal benefits out of the property.
Avoiding Working with Disqualified Persons in a Self-Directed Real Estate IRA
Who exactly matches the description of a “disqualified person” within an IRA? A good rule of thumb is to avoid transacting with people you know. Sisters, brothers, spouses, the list goes on and on—these are all people to avoid transacting with if you own real estate (or any other property, for that matter) within an IRA. You can transact with them in your personal investments, but when it comes to the assets within a Self-Directed IRA, you will want to avoid that.
These are known as “prohibited transactions,” and could result in you being seen as having taken early withdrawals on a retirement asset, since you are now using them for personal use. This comes with taxes and penalties that eat into the gains you were hoping to make when you first made the investment. For that reason, when you begin investing in a Self-Directed Real Estate IRA, it’s important to lay the groundwork with a solid, fundamental understanding of the rules at play.
To avoid working with disqualified persons, one of the best ways is to ensure that you work with a Self-Directed IRA administration firm that can handle the paperwork on the accounts. They can help you ensure that you stay within the rules of retirement investing; however, it’s also important to work with an accountant or a financial advisor if you have specific questions about the sorts of investments you will want to make.