Using your self-directed IRA to buy real estate is a hot topic in the tax world. But there are misconceptions surrounding it. Misconceptions that, if implemented, might cost you thousands in taxes.
One of the big benefits of buying real estate with your IRA is tax deferral. But in order to benefit, it’s important to have all the facts. It can be easy to make a tax or legal mistake…so here are some dos and don’ts for owning real estate in self-directed IRAs.
When did it become legal to own real estate with your IRA?
It has been legal for over 30 years to buy real estate with a self-directed IRA—and it’s much simpler than you might expect. When you purchase real estate directly with your IRA, you don’t directly buy the real estate; your IRA account buys it.
This may seem like a minor distinction but it is, in fact, an important one. All the cost of the real estate purchase must come directly from your IRA to protect your investment from unnecessary taxation.
DO: To pay for your purchase, an invoice and authorization must be sent to the custodian of your self-directed IRA who will then release the funds for the purchase.
DON’T: Pull the money out of your IRA to pay for the purchase of real estate. That withdrawal will be taxable as ordinary income as an IRA distribution.
How do I choose a custodian for my IRA?
Currently there are about a dozen major custodians that offer self-directed IRAs that can hold alternative, non-traded investments like real estate.
DO: Choose a large, established custodian for your self-directed IRA that has a history of playing by the rules and can provide you with clear information on your transaction.
DON’T: Choose a start-up custodian that specializes in just one type of investment or an off-shore custodian that is not governed by U.S. regulations.
Can I buy foreign real estate with my IRA?
Yes, you can—but most foreign countries do not recognize your IRA as a separate legal entity and therefore your IRA can’t buy the real estate. So you will need your IRA to own an intermediary entity that the foreign government does recognize, like an LLC or regular corporation.
DO: Find reputable tax and legal professionals to work with you on both sides of your foreign real estate purchase…people familiar with self-directed IRA regulations and the real estate regulations in the foreign country.
DON’T: Try to go cheap and do it yourself. The legal documentation and procedures for a self-directed IRA purchase are very specific. One small error in titling, and your whole transaction might be taxable as ordinary income.
How can I use the real estate?
Only as a tax-deferral and investment growth vehicle. Rental incomes and expenses, along with gains associated with a sale—if kept in the self-directed IRA—allow you to defer the tax due until you take the money out of your IRA.
DO: Use the property as a rental, providing rental income and capital growth.
DON’T: Personally use the property or personally make any repairs to it…and this includes any family members. These are prohibited actions called “self-dealing” and will cause your investment to be immediately taxable.
DO: Avoid IRS prohibited actions for a self-directed IRA and protect your IRA value from immediate taxation. I go into more detail about those prohibited actions in my tax guide, Expat Taxes Made Easy. It’s the most complete resource you’ll ever find on filing taxes as an expat.
Not only will you learn about buying real estate with your IRA, but I’ll also tell you about some exclusions and deductions you can only claim as an expat (and that can save you thousands of dollars)…how the last U.S. state you lived in can affect your taxes for years after you move…and insider tips on dealing with the IRS should they come knocking on your door.
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