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Investment property may only be used for investment purposes and cannot be lived in (this would constitute prohibited transactions). You are also required to report its value each year with the IRS.
Buying Real Estate
One of the easiest ways to purchase real estate with an IRA is through investing cash directly in properties. Your custodian or an investor may offer guidance here, or perhaps they offer services as an escrow account provider.
However, you are unable to reside in any property owned by your self-directed IRA as per IRS rules that forbid this. Self-dealing, otherwise known as living within or benefitting in any way from property owned by an IRA, is prohibited and should be avoided at all costs.
Your IRA cannot borrow to purchase real estate and you should not personally guarantee its loan agreement. Instead, your IRA must cover the purchase costs itself and hire third-party contractors as necessary to perform any needed improvements or repairs. Furthermore, each year when filing your tax return you must report its fair market value as determined by Zillow; some providers accept Zillow reports while others require professional comparative market analyses as evidence of value.
Managing Real Estate
When making real estate investments with your self-directed IRA, it’s vitally important that you work with an experienced financial advisor and CPA to ensure all rules are followed and benefits fully realized. This is particularly pertinent when investing in properties requiring active management such as rentals.
Once due diligence has been conducted and an investment decision made, it’s essential that all the details of the transaction be communicated to your custodian. This includes how much money needs to be withdrawn from your retirement account, where funds should be sent, any paperwork that needs to be signed, etc. It should also be noted that living or vacationing in property purchased with retirement account funds would constitute a prohibited transaction as per IRS rules.
Owners of Individual Retirement Accounts (IRAs) are prohibited from performing improvements or maintenance work themselves on an investment property; it’s best to hire a third-party service to handle such tasks in order to comply with prohibited transaction rules and achieve full tax advantages for their IRA.
Investing in Real Estate
As its name implies, self-directed IRAs give you ultimate control. Your custodian (IRA provider) will only handle administrative aspects and will not offer investment advice; so it will be up to you to find and evaluate investments yourself as well as ensure no rules or prohibited transactions occur.
Real estate investments make an ideal SDIRA asset, though any use for personal purposes or living purposes would constitute an illegal transaction. Your custodian must report the fair market value of alternative investments such as real estate and private equity to the IRS annually using Form 5498; you should consult a tax professional for guidance to avoid making costly errors and protect your IRA against potential fraudsters.
Taxes on Real Estate
Real estate can be an attractive investment option for a self-directed IRA (SDIRA), but all associated fees, taxes, expenses, and rent must be covered through your retirement account. Furthermore, living on property owned by your IRA would constitute self-dealing – something prohibited by the IRS.
Through a self-directed IRA, it’s also possible to invest in commercial real estate and promissory notes, tax lien certificates, limited partnerships, LLCs, LPs and precious metals. When selecting your custodian it is critical that they offer transparent investment opportunities in order to avoid making prohibited transactions that can incur costly IRS penalties and incur unnecessary expenses. It is also crucial that your research indicates your custodian meets all your needs with regards to fees, services and investments offerings as this will allow you to find one suitable for you and ensure a good fit is found when selecting your custodian.
