Most individual retirement accounts are invested in relatively safe investments such as mutual funds, individual stocks, or long-term bonds. Some IRA owners, however, may prefer a greater degree of diversification in their investment portfolio. Individuals who are knowledgeable about their local real estate market may be able to safely own real estate in a self-directed IRA.

The IRS does not specify the types of assets that can be included in an IRA. In contrast, the tax rules specify which types of assets cannot be held in an IRA. Most financial institutions that serve as IRA custodians prefer the consistency of traditional investments. Even though almost every bank seems to provide regular IRAs, there are significantly fewer financial institutions that offer self-directed IRAs.

Custodian responsibilities

The key requirement to owning real estate in an IRA is the aspect of self direction. The IRA custodian does not perform the selection of assets. The role of the IRA custodian is to ensure that the account meets all of the requirements necessary to maintain its tax-deferred status. After you provide funding for an IRA custodian to purchase real estate, the IRA is considered to be the owner of the property.

IRA growth

Income generated by the real estate must remain in the account until the funds are eventually withdrawn as an IRA distribution. Likewise, the cost of maintaining the property must be funded entirely by the IRA itself. As with other IRAs, the account is likely to increase or decrease in value over time.

Initial funding

An IRA rollover is the most practical method to fund a real estate IRA. The annual limitation on IRA contributions is not enough to pay in full for most real estate purchases. Banks are likely to be hesitant about loaning money to partially finance real estate held in an IRA.

Prohibited transactions

The IRS provides specific guidelines on the purchase and use of real estate held in an IRA. The property cannot be bought from or rented to a disqualified person. The IRS publishes a long list of both family members and entities that fall under the definition of a disqualified person. Even if you have an intimate knowledge of your local real estate market, it is essential to avoid any transaction with a so-called disqualified person.

A real estate IRA can include residential or commercial properties, as well as raw land. Real estate is less liquid than traditional financial assets, so most individuals may be better served by sticking with the liquidity of traditional IRA investments. Contact a financial planner for more detailed comparisons of IRA options.

Contact your local experts for more information about financial planning.