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Why You Don't Buy Real Estate in an IRA

When I hear the same question often enough and within a short period of time, I feel it's the cosmos' way of telling me that this particular topic needs to be addressed head on.  That query?

What are your thoughts on buying real estate in an IRA?

I get why the concept of buying property within an IRA is intriguing.  A lot of people want to get involved in real estate investing, and an IRA is usually their primary source of investable funds.  It seems logical.  On top of that, the powers that be do allow you to purchase physical real estate within a property structured self-directed IRA, subject to some key rules:

  • You or your family can't live in the property for any amount of time, as it should be used strictly for investment or business purposes
  • You can't mortgage the property
  • The IRA must maintain all operating costs and expenses, as you cannot pay these out of your own pocket or do any maintenance work on your own
  • You can't take any tax benefits (operating losses, depreciation, etc.) other than the normal IRA income tax deferrals

If any of these rules are found to be broken, the IRA could be disqualified which would create a major taxable event (very painful, as stated more eloquently by Clubber Lang).

Disqualification aside, it's the limitations imposed by these rules, along with the underlying structure of the IRA that has me pumping the brakes on using an IRA as a vehicle for real estate investing.  Here are the reasons why I'm staying away:


Real Estate is Already Tax Friendly

As an investment, there is almost nothing that avoids the IRS quite as effectively as real estate.  If investing correctly, you should pay very little of your income and profits to the tax man.  Rental income is shielded by deductible items such as taxes, insurance, expenses, management fees, and the big boy of depreciation (among other misc. items).  Capital gains on the increased value of the property when a sale takes place can be deferred through proper use of a 1031 like-kind exchange.  At death, you can also pass along the property to your heirs with a stepped-up cost basis, meaning the investment could potentially live through multiple generations paying very little (if anything) in income taxes.

Why then would you place such a tax-advantaged asset in a tax-advantaged account?  You wouldn't place your beer fridge inside your home refrigerator.  It has no added benefit.

In fact, you are making real estate less tax friendly if you do place it inside an IRA.  By doing so, you still have to follow the traditional rules of an IRA that require you take distributions from the account starting at age 70 1/2.  These distributions are guaranteed to be taxed as ordinary income.  And what if you don't have liquid assets to distribute?  You are then forced to sell the property to make the distributions; likely not what you had in mind.

Leverage Benefits Would Be MIA

One of the most powerful advantages to investing in real estate lies in the ability to use other people's money (OPM, cousin to OPP) to purchase assets.  You can control 100% of a property by putting down as little as 3.5% (or sometimes less if you're creative) of your own money.  This is called leverage.

The benefits of leverage lie in the numbers.  Let's say you purchase a $100k property using a more traditional down payment of 20%.  If this property puts $2,400 of net cash flow into your pocket in the first year while also appreciating 3%, your year-one return on the $20k down payment would be approximately 27%.  If paying all cash, that return would be reduced to roughly 10% (assuming you nix a theoretical $80k mortgage payment of $4,750/year).

By purchasing inside an IRA, you forgo your ability to place a mortgage or loan on the property; hence you forgo all the benefits that leverage can bring to the table.  No good.

Hurts Dreams of Early Retirement

Thinking of retirement at 60

The primary reason I'm investing in real estate is to help build my passive income streams in route to early financial freedom.  By placing a property in an IRA, I can't access those income streams until age 59 1/2 without paying a penalty.  I don't know about you, but 59 1/2 is not my definition of early retirement!

Bottom line is if you want to get out of the rat race earlier in life, a solid real estate investment can be a ferociously strong ally if held outside of an IRA (kind of like having your own financial version of Drogon), or it can be just like any other rather bland investment if held inside an IRA.

Reduced Diversification

Why not use an IRA to house the type of assets it was designed to house:  traditional equity/stock and fixed/bond assets?  IRAs do a great job of growing these holdings in a tax-advantaged fashion.  Better yet, by having this blend of investment holdings, you also keep a nice balance in your overall financial picture.  This is called diversification.  If you use your IRA to purchase an investment property while also buying properties outside of an IRA, you have then put yourself in a position of concentrated risk; the equivalent of having all your eggs in one basket.

You might have conviction in one area of the markets or a style of investing relative to others (I do as well), but it's hard to argue against the benefits of moderation and balance in one's world; something I wish we had more of in D.C. these days too.


At the end of the day, the companies I see pushing the self-directed IRA option to purchase properties are those in the business of selling real estate.  This should tell us something.  We have to keep in mind the motivations behind the message we are hearing, as we can tell a lot about someone's drive by understanding how they are compensated.

By taking into consideration the main points above, I see it rarely making financial sense to purchase real estate within an IRA (absent very few exceptions).  If you've been exploring this option, feel free to reach out so we can discuss in further detail.  This is a decision that can have a big time impact on your future.  Learn from mistakes in other areas of life such as dinner decisions and that random unicycle purchase, not in your path towards retirement.