How to Hold Real Estate in an IRA

It often surprises people to learn that you can hold actual, physical real estate in an IRA. But really, it shouldn’t be much of a shock.  The IRS rules regarding investment choices within an IRA are amazingly broad. In fact, you can hold just about any investment in an IRA except for collectibles and life insurance. That means that real estate has a green light.

But beyond the legalities, how do you hold real estate in an IRA? As you might expect, it is a more involved process than is the case with traditional paper investments.

The Benefits of Holding Real Estate in an IRA

We’re going to get into the mechanics of holding real estate in an IRA. But first, let’s talk about why you might want to do it in the first place.

Real estate offers one of the most significant diversifications available compared to traditional paper assets. It is a tangible asset; in fact, it is the largest tangible asset you can hold. That alone can be a significant diversification, compared to stocks and bonds.

There is one very big advantage that real estate can offer within an IRA, though. More than most other types of investments, real estate is generally a very good hedge against inflation. When you are investing over a period of decades, that has to be factored into your investment strategy.

Much of the wealth created in America has been generated by real estate. And the long-term nature of both real estate and retirement plans actually matches up well in this regard.

Learn More About Real Estate Investing

Perhaps the biggest benefit comes from what an IRA can do for your real estate investment. It can turn what has traditionally been one of the best long-term investments into a completely tax-sheltered venture. You can have all the benefits that investing in real estate brings, but add tax protection to the mix. Once included in an IRA, both the rental income and capital gains from the sale of an investment property will be tax-deferred.

Imagine for a moment the advantage that would come from the sale of an investment property which generates a six-figure capital gain? It would provide a massive benefit with no immediate income tax consequences.

This is precisely why there is an interest in holding real estate within an IRA.

Real Estate in an IRA – The Mechanics

As you might imagine, adding real estate to an IRA is a complicated process. Certainly more so than is the case with paper assets.

To start, you have to find an IRA trustee who specializes in real estate IRAs. That’s the first challenge, since very few trustees operate in this market. In fact, the major IRA brokerage platforms we all know and love — such as TD Ameritrade, Betterment, or Wealthfront — do not allow it. (We’ll discuss real estate IRA trustees in some detail in the next section.) Once you have a trustee, your IRA account can be set up in a similar fashion to one that holds paper investments.

Given the size of a single real estate investment, it’s likely that a real estate IRA will be created by rolling over funds from existing IRA accounts. Real estate IRAs are subject to the same contribution limits as other IRAs, limiting you to $5,500 per year, or $6,500 if you’re 50 or older, in 2016. A typical real estate investment usually requires considerably more. If it’s created with a rollover IRA, or 401(k),  the transfer will be similar to the rollover of any other type of retirement plan to an IRA.

Before we move on, I do need to call your attention to a critical factor in regard to real estate IRAs. Any property in the account must be legally titled in the IRA, and not in your name. If you’re thinking that you can own real estate in your own name, but reap the tax benefits of keeping the property in an IRA… well, it unfortunately doesn’t work that way.

In fact, it’s not even you who can make the purchase of the property. You will need to complete forms that direct the IRA trustee to make the purchase for the account. The purchase will then have to be handled entirely by the trustee. You cannot be involved in it at all.

The money used to purchase the property must also come from the IRA, and not from you. Income earned by the property must be retained in the IRA account. When the property is sold, all proceeds from the sale must also be retained in the IRA. Your only input in the process will be that you will need to agree to the final sale price of the property. In the meantime, you’ll not be able to participate in the purchase, maintenance, and sale of the property. It is entirely, legally part of your IRA.

The IRA also maintains all ownership and transaction records connected with the property within the IRA. In a very real way, a real estate IRA is far from a self-directed plan.

Finding an IRA Trustee Who Will Accept Real Estate

Very few IRA trustees are interested in being property managers. Therefore, it’s understandable that the field for real estate IRA trustees is narrow. But there are trustees out there who do handle real estate IRAs, even if they aren’t exactly household names.

Possible trustees for your real estate-holding IRA include:

I’ve provided this short list of potential real estate IRA trustees, but please understand that this is not necessarily an endorsement of these companies. These are simply IRA trustees who are known to offer the opportunity to place and hold real estate in an IRA. However, this is a very specialized field. I strongly advise that you  research on each company if you’re interested in a real estate IRA.

The Drawbacks of Holding Real Estate in an IRA

As noted earlier, a real estate IRA is not a self-directed account. It is essentially a dedicated IRA account that invests only real estate. You will have no control over any aspect of that ownership or management.

This means that you cannot use a real estate IRA as a legal- or tax-shell for the purpose of acquiring, managing, and selling real estate. It is an IRA that invests in real estate for your eventual benefit.

Should you actively participate in any part of the investment process, the IRA account can be invalidated by the IRS. They can disqualify the entire plan, and reclassify it as a distribution. Should that happen, the distribution will be subject to ordinary income tax as well as the 10% early withdrawal penalty. This is another major reason why typical IRA trustees don’t handle real estate IRA accounts.

There are rules designed specifically to eliminate your participation:

  • Transactions must be “arms length” — The IRA cannot purchase property that is owned by you, anyone you’re related to, or any person or entity with whom you have a business relationship.
  • No “indirect benefits” — Property owned by your IRA cannot be used as a second home, a place of business, or even as a storage facility for your belongings. ‘No personal use’ means no personal use of any kind.
  • Non-recourse financing only — Any financing taken on the property must limit the lender’s recourse to the property only, and not to other assets, including those that are part of the IRA.
  • All financial activity must remain in the IRA – Rent income and sales proceeds must go back to the IRA. All expenses paid in connection with the property must be paid out of the IRA.

A violation of any of the rules connected with a real estate IRA will result in a distribution of the entire IRA, and trigger the tax consequences of an early distribution.

If You Don’t Want Actual Real Estate You Can Use REITs

Despite the benefits of holding real estate in an IRA, it does have significant drawbacks. So, what if you would like to hold real estate in your IRA, but don’t want to deal with a true “real estate IRA” and its complications? Well, you can always invest in real estate investment trusts, or REITs.

REITs are something like mutual funds for real estate. They can hold either an equity position in real estate (usually commercial or industrial property, or large apartment buildings or complexes), or they can hold mortgages on those properties.

Learn More: Beginner’s Guide to REITs

REITs pay dividends that are generally higher than what you can get on interest-bearing investments, and even high dividend yielding stocks. As of August, the average dividend yield on REITs is 3.87%, but you can find REITs that pay much higher dividends. For that reason, they are excellent long-term investments. They also make the perfect kind of investment to hold in a tax-sheltered account.

Real estate is an excellent asset to hold in a retirement account, since it has such tremendous long-term growth potential. If you want to consider holding it directly through a real estate IRA, carefully investigate the requirements and limitations, as well as the trustees who will hold the account. But if you decide not to go that route, you should certainly consider adding REITs to your retirement investment mix.

Do you have experience with either real estate IRAs or REITs? How do you feel they have contributed to your portfolio?

Published or Updated: October 23, 2016


  1. Paul Andrews says:

    This post got me super excited! I was thinking you could take the interest deduction on your mortgage to lower your taxable income while it grows, AND not pay any taxes on the income from the property when you start pulling at 59 1/2 (if it was in a Roth IRA)! Sad that you need to be so far removed from the transaction in order to do the deal. Are the tax laws pretty much the same across Roth IRA’s and Traditional IRA’s when it comes to holding real estate? AWESOME post, thanks for sharing!

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