Real estate is a popular investment choice for people who have a self-directed IRA, but it’s a much different asset class than investments like stocks or bonds. Real estate requires a much greater level of planning and monitoring throughout the holding period of the investment, and for this reason some individuals choose to create separate self-directed IRAs for each of their real estate investments. Here are some factors to take into account when you’re faced with that decision.
Carrying Costs. As you consider whether to set up a separate self-directed IRA for a particular piece of real estate, you will need to plan for how you’re going to cover the maintenance and upkeep of that piece of real estate. These expenses and fees will include annual property taxes, physical upkeep and repairs of the property, insurance premiums, plus any other expenses that you’ve agreed to bear on behalf of your tenant.
You can cover these costs with whatever income the property itself generates, or with your permitted annual contributions to an account, or some combination of both. But you are not allowed to use any outside or personal funds to pay any expenses or fees related to your real estate investment.
Distribution Matters. It’s also worth considering that, depending on whether your self-directed IRA is set up as a traditional account or not, you may be responsible for a significant tax liability upon taking a distribution of the property in retirement. If your self-directed IRA is set up as a traditional account, you’ll have to pay taxes on the full amount of the distribution – i.e., fair market value of the property. If your account is set up as a Roth self-directed IRA, then you’ll have no tax liability upon distribution once you reach retirement age.
Furthermore, a traditional IRA will be subject to the IRS rules on required minimum distributions, and this can be particularly difficult to comply with if the only asset in the account is a single piece of real estate.
Prohibitions on Self-Dealing. But even if you set up a separate self-directed IRA to hold a piece of real estate, you still need to be aware of and have respect for the IRS prohibitions on self-dealing. This means you cannot engage in any personal use of your investment property while it’s still in your account, nor can any of your family members or other related parties make use of the property. You can only use the property after you take a distribution of it from your account.
There is no minimum threshold for this rule, and even a single day of personal use can open you up to a risk that the IRS would consider you to have taken an early distribution of property.
Think about the entire time-frame of your real estate investment, from acquisition to holding, to eventual disposition. You don’t necessarily need to have a detailed or inflexible plan for this type of investment, but it’s important to consider the issues that you’re likely to face along the way.