Most people mistakenly believe that their retirement accounts must be invested in traditional financial related investments such as stocks, mutual funds, exchange traded funds, etc. Few Investors realize that the Internal Revenue Service (“IRS”) permits retirement accounts, such as an IRA or 401(k) plan, to invest in real estate and other alternative types of investments. In fact, IRS rules permit one to invest retirement funds in almost any type of investment, aside generally from any investment involving a disqualified person, collectibles and life insurance.
One of the primary advantages of purchasing real estate with retirement funds is that all gains are tax-deferred until a distribution is made or tax-free in the case of a Roth account (after-tax). For example, if one purchased a piece of property with retirement funds for $100,000 and later sold the property for $300,000, the $200,000 of gain appreciation would generally be tax-deferred. Whereas, if you purchased the property using personal funds (non-retirement funds), the gain would be subject to federal income tax and in most cases state income tax.
- The deposit and purchase price for the real estate property should be paid using retirement account funds and not from any disqualified person(s)
- All expenses, repairs and taxes incurred in connection with the retirement account real estate investment should be paid using retirement funds – no personal funds from any disqualified person should be used
- If additional funds are required for improvements or other matters involving the retirement account-owned real estate investment, all funds should come from the retirement account or from a non-“disqualified person”
- Partnering with yourself or another disqualified person in connection with a retirement account investment could trigger the IRS prohibited transaction rules.
- If financing is needed for a real estate transaction, only nonrecourse financing should be used. A nonrecourse loan is a loan that is not personally guaranteed by the retirement account holder or any disqualified person and whereby the lender’s only recourse is against the property and not against the borrower.