Real Estate in Your IRA?

With housing prices and interest rates so low, isn’t it a good time to invest your individual retirement account in real estate? Some promoters are pushing properties in IRAs. Think twice before you do.
IRAs typically invest in mutual funds. Yet there is another kind, called a self-directed IRA, which allows you to put different assets inside it, ranging from a business to a private jet to bullion – and investment properties. Life insurance, art and jewelry don’t qualify, according to the Internal Revenue Service.
With real estate in an IRA, you do not manage the property. You must hire a third party to act as your custodian, collecting rents, paying expenses, overseeing upkeep and general property management.
Maybe you think property prices have bottomed out, and you feel strongly that real estate is a good investment. Nevertheless, there are a lot of disadvantages when purchasing real estate with your IRA funds:
Higher tax rates. When you sell real estate within an IRA, any gain distributed is taxed at ordinary income tax rates. This rate can be much higher than the capital gains rate you would pay on the sale of real estate outside of the IRA.
No depreciation. If you purchase a building with taxable (non-IRA) funds, you get to write-off depreciation. This is not the case with an IRA. Depreciation is a significant tax advantage, so why would you want to give it up?
No step-up in basis. Normally, if you die before the sale of investment property, your heirs would get a step-up in basis. That values the asset at its current level, known as the tax basis, not the (usually) lower amount that you paid years ago. With a step-up, heir could sell it immediately and pay no tax. With no step-up, the IRS taxes them on the property’s sizable appreciation, and at ordinary tax rates.
Valuation expense. When you reach age 70 1/2, you are required to start taking Required Minimum Distributions (RMDs) from your IRA. The RMD amount is based on the value of your IRA assets as of Dec. 31 of the previous year. If you own real property, you must pay to get it appraised every year to figure out what your IRA value is.
Lack of liquidity. You must have enough additional funds in the IRA to take the RMD distribution every year starting at age 70 ½-- not easily done if all of your IRA is invested in real property.
Personal Use. You can’t use the property for yourself, even if it’s a timeshare. You can’t rent it to lineal descendants.
Custodial Fees. Brokers and banks generally only allow traditional investments in your IRA like stocks and bonds. If you want to hold real estate, you have to find a custodian that specializes in holding real estate. You pay extra for that privilege.
Expenses. You must use IRA funds for all expenses associated with the property including taxes, repairs and insurance. If rents don’t cover these costs, the IRS may disqualify your IRA. All income must go into the IRA and all expenses flow out of it.
Unrelated Business Taxable Income (UBTI). If you purchase real estate within your IRA using a mortgage, you may be subject to UBTI, requiring that you file a tax return and pay taxes on the income.
If you want real estate assets in your IRA for diversification, you can avoid all these restrictions by purchasing shares in a real estate investment trust, a real estate exchange-traded fund or a real estate mutual fund. These are readily available through your current investment advisor or custodian.
Russell Francis, CFP, CPA, is owner of Portland Fixed Income Specialists in Beaverton, Ore. His website is
AdviceIQ delivers quality personal finance articles by both financial advisors and AdviceIQ editors. It ranks advisors in your area by specialty. For instance, the rankings this week measure the number of clients whose income is between $250,000 and $500,000 with that advisor. AdviceIQ also vets ranked advisors so only those with pristine regulatory histories can participate. AdviceIQ was launched Jan. 9, 2012, by veteran Wall Street executives, editors and technologists. Right now, investors may see many advisor rankings, although in some areas only a few are ranked. Check back often as thousands of advisors are undergoing AdviceIQ screening. New advisors appear in rankings daily.