With today's low home prices and the best mortgage rates in decades, I'd like to buy some investment property for my IRA account. How do I accomplish this? Will mortgage lenders finance investment property held in an IRA?
You can hold real estate in retirement accounts
You can buy real estate for your IRA (or even a single-participant 401-k), and the income and equity pile up tax-free. The account and property purchase must be set up exactly in accordance with IRS rules. Mistakes can be very costly, so smart investors enlist the help of a CPA or other professional before they go property shopping.
If, for example, you bought vacant land for $100,000, and in 5 years you sell it for $150,000, your $50,000 gain is tax-deferred (traditional IRA) or tax-free (Roth IRA). Here's what you have to do:
- Transfer the money for your real estate purchase from your IRA to an independent custodian offering real estate investment options.
- Sign a letter directing the custodian to buy the property.
- Real estate income is deposited into the IRA and expenses are deducted from the account.
But avoid these costly errors
Choose real estate for your IRA for the right reasons--for example, to diversify your portfolio or take advantage of investment opportunities. Don't do it to get a tax-free vacation home (because it won't work!). Here's what you need to know:
- You can't transfer property that you already own into an IRA. It must be purchased by the custodian.
- You can't buy a vacation home for the IRA and then rent it out to yourself or family members.
- You don't get a depreciation deduction.
What about the mortgage?
You can finance your investment property through a mortgage lender or other source. However, the bigger your mortgage, the less income you can shelter. For example, if you buy a rental house for $100,000 and get a $75,000 mortgage, you get hit with unrelated business income tax (UBIT). You'd be able to shelter only 25% of the property's income because 75% of it is financed. The remaining 75% of income and capital gain is subject to ordinary income tax rates.