Understanding all your real estate financing options is a critical component of profitable investing. In fact, identifying the ideal financing method for you is what will allow you to generate a good return on investment and avoid unnecessary expenditures. While you might be familiar with most of the standard investment property financing methods that are used by real estate investors, there are a few less conventional types of loans that you are probably not aware of. An example of this is the IRA loan. So how exactly does this financing method work? Can you take a loan from an IRA? How to invest in real estate with an IRA loan? And should you buy real estate with an IRA loan? This blog will answer these questions and show you how to buy real estate with an IRA loan.
Related: 7 Easy Methods for Investment Property Financing
What Is an IRA Loan?
Before delving any further into the IRA loan concept, we must first clarify a common point of confusion. Despite being widely used in real estate circles, the term «IRA loan» is actually a misnomer. In fact, it is impossible to get an IRA loan since it goes against IRS regulations. The confusion stems mainly from the fact that you can borrow from other types of retirement accounts, namely certain 401(k) plans. Having said that, you can still leverage your IRA funds for a real estate investment. The next section will focus on the options that are available to you when buying real estate with an IRA loan.
Alternatives to Taking a Loan from an IRA
While taking a loan from an IRA is not allowed, there are still a few ways to tap into your funds and use them for investment property financing. Here are some of the most common real estate IRA financing methods.
1- 60-day rollover
For many real estate investors, the 60-day rollover is an ideal alternative to a loan against IRA. As the name suggests, this is essentially a short-term IRA loan that grants you access to your funds for a period of 60 days. You are generally limited to one short-term rollover in a single year and failing to redeposit the amount within the 60-day period will result in taxes and penalties.
2- Roth IRAs
This is another great alternative to borrowing against your IRA for buying an investment property. This method requires converting your traditional IRA account into a Roth one and simply withdrawing funds from it. A Roth is an account that holds after-tax dollar contributions, which means there won’t be any tax liabilities or penalties. Still, make sure to work with a tax expert to ensure everything goes smoothly.
3- Self-directed IRA
A self-directed IRA (SDIRA) is a retirement account that allows for a wide range of investments. Unlike regular and Roth IRAs, a self-directed IRA holds various alternative investments and it is managed by the holder. Opening such an account through a specialized firm will allow you to invest directly in real estate without breaking IRA rules. This is by far the simplest and most straightforward alternative to an IRA loan.
4- Penalty-Free IRA Withdrawals for specific needs
Even if you can’t get an IRA real estate loan, you can still access your funds for certain needs. In fact, IRA loan rules allow for penalty-free withdrawals in these situations:
- Total and permanent disability
- Higher education expenses
- Health insurance premiums when you’re between jobs
- First-time home buyers
- Certain medical expenses
Now that you are familiar with the concept of the IRA loan, let’s go over how to buy a rental property using IRA funds as your main financing method.
Investing in Real Estate with Your IRA funds
Like we mentioned above, the most effective way to invest in real estate with IRA funds is to use an SDIRA. Here is how you can do so in a few simple steps.
1- Pick a real estate investment strategy that fits the IRA structure
The first thing you need to make sure of is opting for a real estate investment strategy that is in line with the IRA structure. It is important to keep in mind that SDIRAs are designed for long-term investments that generate steady income. As a result, strategies such as fix and flip are off the table.
Related: How to Choose the Right Rental Property Investment Strategy for You
2- Set up an SDIRA
The next step is setting up a self-directed IRA through a specialized firm. Due to the complex nature of IRS regulations, this process can be difficult to navigate. This is why retaining the services of a licensed custodian is imperative.
3- Transfer funds from your IRA to the SDIRA
After setting up the SDIRA, all that is left is transferring funds to it from your IRA. The custodian will provide you with all the necessary instructions to ensure the transfer is within IRS regulations. As for the real estate investment process, it is done as an arm’s length transaction. This means that the investment properties that you purchase will be in the name of the SDIRA, and not in your personal name. Moreover, the custodian will be responsible for executing all transactions.
The Pros and Cons of Investing Through an IRA
As is the case with anything in real estate investing, there are pros and cons to buying an investment property with IRA funds. Below is a brief overview of some of the advantages and drawbacks of this approach.
The pros
- You can defer your taxes until the day you decide to withdraw.
- Investing in real estate will help diversify your retirement portfolio.
- Thanks to the consistent rental income and yearly appreciation, real estate investments are the ideal assets for the IRA structure.
Related: Real Estate Investing for Retirement
The cons
- You can’t undertake repairs or directly manage an income property without a custodian.
- You won’t be able to deduct property taxes and other rental property management expenses.
- Navigating the various IRS restrictions can be challenging and failing to satisfy them can lead to hefty penalties.
The Bottom Line
So is investing in real estate with IRA funds a good idea? The answer depends on your level of experience as a real estate investor. If you feel that you are capable of doing the necessary due diligence and avoiding the tax pitfalls that could put you at odds with the IRS, then there is no reason why you shouldn’t explore this option. In the meantime, use the Mashvisor Property Finder to identify the top investment properties in any market!
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