Buying Real Estate in Your IRA

February 29, 2024

Q: I have amassed a significant amount of money in my IRA. Recently, I found an income property that I’d like to buy. I read that IRA money can be used to buy real estate. How do I do that?

A: I’ve written about this before, but it never hurts to reiterate: You can buy real estate in your IRA, but be careful. The IRS has very strict rules about how IRAs can be invested; if you run afoul of those rules, the penalties are severe. Real estate can be particularly treacherous—a fact some taxpayers have learned the hard way. Consider, for example, the case of McClendon v. the IRS Commissioner.

In 2012, McClendon decided to invest his IRA money in a condominium. His IRA custodian transferred the necessary funds to a title company and made the purchase. Then McClendon decided he not only wanted to buy the condo, but live in it as well. When the IRS discovered that he was using the condo as his personal residence, it deemed the purchase a prohibited transaction. All IRA funds used for purchasing and maintaining the property were considered an early distribution from McClendon’s IRA. As such, they were taxable as ordinary income, and subject to a 10 percent early withdrawal penalty. McClendon was also hit with a number of other accuracy-related penalties. McClendon sued the IRS in response, but the Tax Court was unsympathetic. It emphasized that the rules prohibited exactly what Mr. McClendon was doing—using IRA funds for personal benefit.

Some might wonder why using the condo was a prohibited transaction. After all, it benefits the IRA’s owner. Isn’t that what an IRA is for?

To follow the logic here, you first need to understand that your IRA is different from your other investment accounts. It’s actually a legal entity, separate and apart from you. Eventually, you will receive benefits from your IRA—when you take distributions. Meanwhile, you have a fiduciary duty to act in the best interest of that account. Anything that uses IRA funds for your personal benefit violates your fiduciary duty, and is prohibited by the IRS.

If you use your IRA to purchase real estate, consider the following guidelines:

  1. Find a trust company specializing in self-directed IRAs, with experience with real estate. An experienced custodian can keep you out of trouble. Most traditional IRA custodians, like banks and brokerage firms, won’t allow you to purchase real estate in your IRA. Trust companies specializing in self-directed IRAs are easy to find if you search for them online.
  2. Avoid personal use of the real estate. Real estate in your IRA cannot be used by you, your family members, or anyone who is a fiduciary to you. You can’t live in it, vacation in it, or even hire your kids to mow its lawn or wash its windows.
  3. Your IRA must make the purchase and hold title to the property exclusive of you. The IRA cannot buy the property from you, a relative of yours, or a corporation you own. Every penny of purchase money, closing costs, processing fees, etc. must come directly from the IRA account. If you so much as use personal funds to pay the postage for mailing the documents, you are breaking the rules.

The same rules apply after the IRA owns the property. All money for improvements, maintenance, property taxes, insurance, etc., must come from the IRA.

  1. Finally, watch out for leverage. If you intend to make a down payment with cash from your IRA and finance the balance, the complications multiply. Your IRA must borrow the money, not you personally. You cannot guarantee or co-sign the loan. And the loan must be nonrecourse—meaning that if the IRA stops making payments, the lender cannot claim other IRA assets. That kind of loan will be difficult to find. Even if you are fortunate enough to secure such a loan, the income attributable to the debt will be considered Unrelated Debt-Financed Income and will be taxed at trust tax rates, which can be significantly higher than individual tax rates.

Please see important disclosure information here.

Steven C. Merrell MBA, CFP®, AIF® is a Partner at Monterey Private Wealth, Inc., a Wealth Management Firm in Monterey. He welcomes questions you may have concerning investments, taxes, retirement, or estate planning. Send your questions to: Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA  93940 or email them to smerrell@montereypw.com.