Lifepoint Financial Design – LifePoint Financial Services – Mike Metzger Financial Planning

Occasionally I come across people asking me about self-directed “real estate” IRA’s and whether or not I offer those types of accounts. The short answer is that I do not. The longer answer is that even if I did, I would never recommend it. I know this might be an unpopular answer to most real estate agents and high-income earning investors, but I will provide in-depth reasoning as to why I don’t believe it is in the best interest of most.

1. Real Estate ALREADY has a tax-friendly status with the IRS

Capital gains are exempt from taxation up to $500,000 (must meet the IRS qualifications to receive the exemption). In addition, this exemption can be used more than once. The IRS is not very charitable, but it certainly seems like they were in a good mood on this one.

Created by the Tax Cuts and Jobs Act (TCJA), passive rental income may qualify for a pass-through deduction which allows investors to deduct up to 20% of their net business income and thus reducing their effective income tax rate by 20%.

The amount of deductions that you can take on your real estate is plentiful. For starters, mortgage interest, with some limitations, and associated costs are deductible on your tax return. Beyond this, items like property taxes, operating expenses, depreciation, repairs, maintenance, property management expenses, and even home-equity lines of credit may also be deductions on your tax return.

The IRS code section 1031 allows an investor to defer a capital gain from selling a property in exchange for purchasing another property that is equal or greater in value. This could provide tremendous value to a client’s tax situation and asset side of the balance sheet.

With all of these tax-friendly benefits, it doesn’t make sense to place an already tax-advantaged asset inside of a tax-friendly account, because eventually you will have to take the assets out…only that means that you have to sell the property regardless of current real estate market conditions. I’ll explain. 

2. IRA’s Require Mandatory Distributions; And The IRS Doesn’t Care If It’s Real Estate

When an individual turns 70.5 years of age, if 70.5 before January 1, 2020 or 72 years of age after January 1, 2020, the IRS will require you to take out a portion of your account to be taxed. The penalty for not complying is a large 50% of what was required to be taken, in addition to the ordinary income taxes due on the withdraw! However, this becomes a challenge when your IRA funds are in a relatively illiquid asset. You can’t exactly chip off a piece of a window sill to turn in for cash (at least not with the exchange occurring within your IRA).

3. There are some very restrictive rules to a self-directed IRA containing real estate

  • You or your family cannot live in the property for ANY amount of time and must be maintained for strictly business purposes

  • You cannot mortgage the property, so HELOC’s are out too

  • The IRA must maintain all operating costs and expenses and those items cannot be paid for out-of-pocket

  • You cannot perform any of the maintenance work on your own

  • You cannot take any real estate tax benefits, as you are already receiving the normal IRA tax-deferral.

  • If any of the above rules are broken, the IRA is disqualified and it all becomes taxable income

4. Loss of diversification

This to me is the biggest reason of all. As a real estate agent or high-income busy professional, dependent upon real estate portfolio income, you mean you are going to buy more real estate in your retirement account? There is some serious risk associated with that move.

The point of a retirement account is to have another pool of assets that will provide you with a source of assets/income to cover retirement expenses. It would be devastating to have your income, your real estate portfolio, and your retirement decline in value due to market conditions right before that desired retirement date. That is called having all your eggs in one basket.

Let your IRA be an account for its desired use- to hold stocks, bonds and other liquid investments on a tax-advantaged basis that also has much flexibility to get to those funds out when needed.

Bottom Line

Real estate is a very valuable tool for tax reduction, long-term growth, and current income. But an IRA is just not the place to hold it. An IRA already provides significant benefit in its own way and provides the liquidity and diversification that allows you to have some moderation in your financial life. It is just not worth throwing that out to obtain another piece of real estate.


Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. 

Asset allocation does not ensure a profit or protect against a loss.

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.

Traditional IRA account owners should consider the tax ramifications, age and income restrictions in regards to executing a conversion from a Traditional IRA to a Roth IRA. The converted amount is generally subject to income taxation.

All investing involves risk including loss of principal. No strategy assures success or protects against loss. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.

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