How IRA Funds Impact Real Estate Investment Opportunities

If you’re a serious retail investor, you probably already know a few things about IRAs like how they allow you to grow funds without having to pay income taxes on any profit made by the principal.

What you might not be aware of is the fact an IRA can also be used to purchase real estate. At times, it’s financially savvy to purchase properties with your IRA, but you need to understand which rules to follow in order to purchase real estate property using your IRA account funds and not have to pay taxes on income made by the property.

Here are a few things you should know before deciding to purchase real estate with your IRA:

1. Your Funds Can Become Taxable

One of the most attractive things about IRAs is the fact the funds are tax-deferred. In the event that you decide to buy real estate without following all the proper rules, your IRA can become disqualified, making the funds in it taxable.

That’s the type of mistake most people would like to avoid. There are many rules you have to follow to prevent your IRA from being disqualified when making a real estate purchase is:

  • All work on the property must be done by an independent contractor or home remodeling business.
  • You do not claim depreciation or try to get tax breaks if the investment operates at a loss.
  • The property can’t be mortgaged.
  • You cannot gain any personal benefits from owning the property. You are not allowed to live in it or use it for personal activities. The property must be used solely as an investment.
  • All income made from the property must be deposited into the IRA, and all repairs and maintenance costs must be paid for with funds in the IRA.

2. You Miss Out On Huge Tax Breaks

Any income earned from real estate properties purchased with funds in your IRA become taxable when you decide to make withdrawals. The exception would be Roth IRAs which allow you to grow and withdraw investment profits without paying any tax. For example, if you decide to buy one of the houses for sale in NJ with a Roth IRA, you won’t have to pay taxes on the income earned from the property even when you make withdrawals.

A good benefit of investing in real estate is the depreciation, which allows you to get a tax deduction. However, as mentioned earlier, you will not be able to claim any deductions or losses if you purchase properties with your IRA since that would disqualify your account. That means you forfeit any tax breaks if you use your IRA to fund your real estate purchase.

3. You Still Need To Take Minimum Distributions As Required

The way IRAs work, once you’re over 70 ½, you’re required to take the minimum distribution allowed. When you purchase properties with IRA funds, you might not have enough funds to cover the withdrawal, and you most likely won’t be able to sell the property off in portions to cover the distribution.

You can end up with a disqualified account if you find yourself in this scenario. Roth IRAs are generally better for real estate investments given the fact they allow you to grow and withdraw gains tax-free.

4. You Have Restricted Real Estate Uses

Purchasing real estate using your IRA accounts restricts the purposes you can use your home for. When you purchase real estate with traditional financial instruments, you have the ability to use properties however you like. Whether you want to purchase properties, rent them to others, or flip homes, you are free to do so. When you purchase properties using your IRA, you must use it strictly for investment purposes. Therefore, you and your family cannot use properties for residential purposes. Depending on your original purposes for purchasing property, these restricted uses frequently cause unfavorable conditions. If you are planning on recharacterizing your IRA account to purchase real estate, be aware of restricted property uses.

Figuring Out If You Should Purchase Real Estate With Your IRA

Purchasing properties with cash from your IRA is a great idea if you are an experienced investor who has a good understanding of all the margins associated with property development. Sure, you will have to postpone taking any income or gains until you’re 59 ½, but you will be able to flip properties or accumulate rental properties and use profits from one project to fund the next without any tax consequences.

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