Can My IRA Invest In Real Estate?

Jim Marshall, LLC

Every year I get this question from clients wanting to invest in real estate through their IRA or SEP IRA. While it is not as straight forward as buying stocks, mutual funds or bonds it is doable if the proper steps are followed and adhered to. First you would transfer the existing IRA to a self-directed IRA, your banks and brokerage firms will not handle these type accounts. Then form a dedicated LLC to own the properties, it will have no other business except that of the investments by the IRA.

The taxpayer should not co-mingle his funds with those of the dedicated LLC. This includes mortgages, guarantees, insurance and other indirect enhancements to the LLC or loans or advances by the LLC to the taxpayer or one of his other entities. Therefore, one of the key considerations is does the LLC have sufficient funds to carry the properties without debt? With the current credit environment borrowing from traditional sources without credit backup is difficult.

Consider the costs. This structure would require annual tax returns be filed for the LLC and the Self-directed IRA Trustee would also have an annual fee.

The next question is what type of real estate should I buy. There are basically 3 types to consider,

  • rental properties either residential or commercial,
  • property for construction and then either hold or sell, and
  • rehabs, the fixer uppers to flip when done.

Each of these can have pitfalls but the rental units in a stable market can be the least headaches. In the construction and rehabs the trap is that the taxpayer or one of his entities should not be doing the construction or contract work. The LLC should hire its contractor and subs independent of the taxpayer. This would not preclude the taxpayer individually doing some incidental work on the property without compensation.

For tax purposes the IRS Code requires depreciation on the rental properties and thereby, at least in theory, increasing the long-term capital gain on the sale of the property. Since the funds are those of an IRA there is no benefit from the capital gain and the net proceeds from the sale would be returned to the IRA Trustee. The LLC cannot sell the property to the taxpayer, that would be a prohibited transaction.

If you think this process is too much work or to complicated your regular IRA or SEP could by REIT stock, invest in master limited real estate partnerships or private REIT’s.

Jim Marshall

Jim Marshall brings years of experience in tax and audit in a wide range of public and private companies large, medium and small. His experience includes responsibilities for major land acquisitions and dispositions and their structuring including publicly-held banks, savings and loan associations, mortgage bankers, real estate developers, insurance companies, builders and contractors. In addition to a strong background in all phases of tax and audit, Jim is a proven innovator and solution developer on both traditional and nontraditional alternatives.

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4 comments on “Can My IRA Invest In Real Estate?

  • Thanks Jim!
    Similarly, can a self directed IRA invest in high-end cars held for investment purposes?

    • Scott, yes you can, it would be similar to investment by an IRA in Gold, Silver, or other collectibles. The caution would be that you can not benefit from use of the car, or even the real estate discussed earlier. That might trigger the conversion to an IRA distribution and become taxable

  • Great post Scott! As a follow up piece for consideration… what about the 5498 reporting and/or the 5500? Also why are some practitioners advising that taxpayers engaged in this activity file IRS Form 1065? Also FYI – it was not too terribly long ago that this was on the IRS’ list of ‘dirty dozen’ tax scams I believe. They of course have bridled their rhetoric since.

  • John, let me address the forms issues you bring up. 1) Mechanically, once a year the LLC would report the net asset balance to the special purpose trustee and that trustee would report the balance on a for 5498 back to the taxpayer. 2) Since this is an IRA account no 5500 is due, as a side note I have not seen and do not believe that this process would be available for a pension plan or 401-K, but would have to research this further to be sure. 3) The 1065 allows the taxpayer to transact business in the name of the self-directed entity and open bank accounts, pay bills, collect rents. This is usually harder to do as a Trust entity and this would give you an EIN to track transactions and not co-mingle with your personal business.
    If your activity was more passive like holding a vintage auto and then latter selling it this elaborate system may not be necessary.
    As to tax scam I do not recall this ever being on the dirty dozen list especially when controlled by the ultimate beneficiary, the taxpayer.

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