How to Buy Rental Homes Using an IRA

When it comes to investing in real estate, it can be difficult to finance the initial purchases. In many cases, those who would like to invest in rental properties don’t—simply because they don’t think they can.

But, did you know you can actually purchase rental homes with your IRA?

Here’s the deal…

What is an IRA?

An IRA, or Individual Retirement Account, is a form of retirement plan utilized by a large population of the US. These accounts, hosted by a range of large financial institutions, provide tax advantages which a regular savings account would not, making them a popular choice for growing retirement funds.

Essentially, IRAs allow you to grow your funds without incurring any income or investment taxes.

Many people opt to use what is called a self-directed IRA. Self-directed IRAs are slightly different than a traditional IRA in the fact that they allow you to invest in other avenues, such as stocks, bonds, options, mutual funds, ETFs, and REITs.

But, they are also great for investing in real estate.

Rules to Using an IRA to Invest in Rental Properties

Using an IRA to invest in real estate isn’t a simple cut and dry process, but it is very do-able—even for first time investors. The major point of notice when attempting to do this type of transaction is to realize that you and your IRA are not a joint task force. The entire process has to be overseen by a legal custodian to ensure there are no violations of the rules put in place to govern these types of transactions. The custodian will manage the entire process, including any buying/selling transactions, associated paperwork, and financial reporting. A custodian will charge a fee for the service, so make sure to account for that in your budgeting.

Most importantly, you need to understand that your IRA owns the property—not the other way around.

There are several strict regulations put into place that govern this property, too. The property must be used to generate an investment income, not a personal income.  It also cannot be used as a vacation home, an office, or rented to family members. It also has to be a new purchase, not one which you already owned.

Things to Know about Using an IRA to Invest in Rental Properties

As the property will be owned by your IRA, not you, there are a few snags that you need to be aware of. When you purchase a property using an IRA, any expenses incurred by the property—such as maintenance—comes out of your IRA’s funds, not yours. Of course, this also means that any income generated by the property returns to the IRA, not to your pocket. If you are looking to purchase property to add a monthly income to your checking account, this isn’t the way to do it. However, if you are looking to add to your tax-free IRA account to save towards retirement, then this is a great way to accomplish that.

Another important different to be aware of when using an IRA to purchase property is the tax situation. As an IRA is already exempt from incurring taxes and the IRA will own the property, you are therefore exempt from collecting any of the tax deductions that accompany owning a rental property. In addition, if the property is purchased by the IRA you are unable to pay for any repairs, maintenance, or updates to the property out of your pocket—so be sure your IRA has plenty of available funding before moving forward with this route.

Selling your Rental Property

When it comes time to sell the property, the process remains relatively the same. You would list the home on the market and wait for a buyer to make an offer. If you accept the offer as is, you would move forward; if not, you simply negotiate as you would with any other real estate holding. Once everyone has agreed upon a final price and any additional terms, then the process begins to differ. Instead of acting on your own behalf during a closing process, the IRA’s custodian handles the remaining process, selling the property on behalf of your IRA. When the sale processes, the money would simply be placed back into your IRA. Depending on your IRA’s form, it will either be tax-deferred or completely tax free.

While it may sound complicated at first, buying a rental home using an IRA is actually much easier than you would think. As the process legally has to be handled by a custodian, you don’t have to worry about the ins and outs. All you have to worry about is researching and vetting the person or financial company you opt to use as your IRA’s custodian and they will take it from there.