A common question among self directed IRA investors is, “Can I buy a future retirement home with my IRA?” Yes, you can buy a future retirement home with your IRA but you need to understand the rules and drawbacks before doing so. The strategy essentially works in two phases. First, the IRA purchases the property and owns it as an investment until the IRA owner decides to retire. Second, upon retirement of the IRA owner (after age 59 ½) the IRA owner distributes the property from the IRA to the IRA owner and the IRA owner then takes ownership of the property personally and may now use it and benefit from it personally.
Before proceeding down this path, an IRA owner should consider a couple of key issues.
Avoid Prohibited Transactions– The prohibited transaction rules found in IRC Section 4975, and which apply to all IRA investments, do not allow the IRA owner or certain family members to have any use or benefit from the property while it is owned by the IRA. The IRA must hold the property strictly for investment. The property may be leased to unrelated third parties but it cannot be leased or used by the IRA owner of prohibited family members (e.g., spouse, kids, parents, etc.). Only after the property has been distributed from the IRA to the IRA owner may the IRA owner or family members reside at or benefit from the property.
Distribute the Property Fully Before Personal Use – The property must be distributed from the IRA to the IRA owner before the IRA owner or his/her family may use the property. Distribution of the property from the IRA to the IRA owner is called an “in-kind” distribution and results in taxes due for traditional IRAs. For traditional IRAs, the custodian of the IRA will require a professional appraisal of the property before allowing the property to be distributed to the IRA owner. The fair market value of the property is then used to set the value of the distribution. So, for example, if my IRA owned a future retirement home that was appraised at $250,000, then upon distribution of this property from my IRA (after age 59 ½) I would receive a 1099-R for $250,000 issued from my IRA custodian to me personally. Because the tax burden upon distribution can be significant, this strategy is not one without its drawbacks. Some owner’s will instead take partial distributions of the property over time holding a portion of the property personally and a portion still in the IRA to spread out the tax consequences of distribution. This can be burdensome though as it requires appraisals each year to set the fair market valuation. While this can lessen the tax burden by keeping the IRA owner in lower tax brackets, the IRA owner and his/her family still cannot personally use of benefit from the property until it is entirely distributed from the IRA. Many investors will use an IRA/LLC and will transfer the LLC ownership over time from the IRA to the IRA owner to accomplish distribution.
For Roth IRAs, the distribution of the property will not be taxable as qualified Roth IRA distributions are not subject to tax. For an extensive discussion of the tax consequences of distribution, please refer to IRS Publication 590.
Additionally, keep in mind that the IRA owner should wait until after he/she turns 59 ½ before taking the property as a distribution as there is an early withdrawal penalty of 10% for distributions before age 59 ½.
As stated at the outset of this article, while the strategy is possible it is not for everyone and certainly is not the easiest to accomplish. As a result, self directed IRA investors should make sure they understand the rules (no personal use while owned by the IRA) and drawbacks (taxes upon distribution and before personal use) before purchasing a future retirement home with their IRA.