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Invest in Real Estate Using Your Roth IRA

Invest in Real Estate Using Your Roth IRA

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Larry Alton

Larry is an independent, full-time writer and consultant. His writing covers a broad range of topics including busine...

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As an investor looking to build wealth and retire early, you’ve likely considered taking advantage of a Roth IRA, a special type of retirement account that doesn’t require you to pay taxes—provided certain conditions are met, like a minimum age for withdrawal.

In a Roth IRA, you can contribute up to $6,000 per year (in 2019) and use those funds to invest in assets like stocks and bonds.

If you’re reading this blog, you’ve probably also considered investing in real estate as a way to build your wealth, whether through flipping properties, renting or leasing, or hanging on to real estate long-term with the hope its value increases over time.

What you may not realize is it’s possible to invest in real estate using funds allocated to your Roth IRA—in other words, holding real estate within your Roth IRA. But is this a good idea?

Self-Directed Roth IRAs

Traditional IRAs only allow you to buy and exchange conventional assets like stocks, bonds, ETFs, and mutual funds. However, you also have the option of pursuing a self-directed IRA. These accounts have the same tax advantages as their traditional counterparts, but offer more flexibility with what you can buy and sell.

For example, you can use the funds of a self-directed Roth IRA to hold partnerships, tax liens, single-family homes, multiplex homes, apartments, co-ops, condominiums, or even vacant land.

The catch is, you’ll need a “custodian” (an individual or a service) to handle your account. Finding a custodian that specializes in self-directed IRAs can be tricky.

The popular names you’ve heard associated with Roth IRAs may not offer a self-directed option for the sake of keeping their business models simple and approachable. You’ll need to find someone capable of understanding the ins and outs of real estate purchases, in addition to being a self-directed IRA custodian.

Related: The 5 Best Investments in My Self-Directed IRA

envelope with cash and change falling out labeled Roth IRA in permanent marker with glasses on a desktop

Advantages of Roth IRAs

So, what are the advantages of using funds contributed to your Roth IRA to purchase real estate?

  • Tax-free growth. The biggest advantage here is the potential for tax-free growth. Assets held in a Roth IRA can essentially grow tax-free, provided you don’t withdraw the gains before you’re 59.5 years old. The stipulation here is that only Roth IRA funds can be used to purchase the property to see this benefit. It’s possible to finance part of the home, but only the equity paid for with Roth IRA funds will be eligible for the tax-free benefits.
  • Tax-free rental income. Assuming you’ve paid for the house entirely with Roth IRA funds, you’ll be eligible to collect tax-free rental income. Of course, things get more complicated if you’ve financed your home with funds or a mortgage outside your Roth IRA.
  • Consolidation. Keeping your real estate within the confines of your Roth IRA may also make it easier for some people to segment their real estate investing strategies. One or a handful of properties can serve as your “retirement” portfolio, while you pursue other interests outside the Roth IRA.

Related: The Ultimate Guide to Real Estate Taxes & Deductions

Disadvantages to Roth IRAs

To be sure, there are a few disadvantages to this approach.

  • Finding a custodian. Not all Roth IRA custodians are willing or qualified to take on a client trying to purchase real estate. This can be a long and messy process, and not everyone who claims to be able to handle these transactions is worth working with.
  • Dealing with fees. Some custodians charge extra fees for complex transactions, especially those that handle real estate. This could potentially cut into the value of your deals or the profitability of your purchases.
  • The complexities of partial ownership. As you’ve seen in the preceding sections, things can get complicated if you’re using your Roth IRA funds to purchase only part of a home or as a down payment. Taxes can get complicated, as well, unless you’re paying for the entirety of the property.
  • Depreciation claims. Under normal circumstances, it’s possible to claim depreciation on your rental property as a way to save money on taxes. However, this isn’t possible if you’re holding the property in a Roth IRA.
  • Limits on personal maintenance and property use. You also can’t use the property for certain functions if you’re holding it in a self-directed Roth IRA. For example, you can’t live in it or run a business with it, and you may not be allowed to personally maintain it.

binder labeled REIT, calculator, house figurine on desktop

REITs: An Investment Alternative

If you’re hoping to get some real estate exposure in your existing Roth IRA without dealing with the complexities of self-direction or real estate ownership, there is an alternative: real estate investment trusts, or REITs. REITs can be bought and sold much like traditional assets like stocks and bonds, but they represent fractional shares of ownership in a selection of properties—like apartment complexes, residential properties, healthcare facilities, office buildings, and more.

Since you won’t be able to live in or directly manage the property you’d buy within a self-directed Roth IRA anyway, this isn’t much of a difference.

Key Takeaways

It’s definitely possible to purchase a property using your Roth IRA, provided you have a self-directed account. But considering the sheer number of complexities involved, you’ll have to decide for yourself if it’s worth the extra effort.

In some situations, this can be an advantageous way to secure practically tax-free growth for your property. But in others, it’s better to stick to investing in REITs within your Roth IRA, while purchasing any real properties with other funds.

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Want to learn how you could be saving more on your real estate taxes using loopholes, deductions, and more? Get the inside scoop from Amanda Han and Matthew MacFarland, real estate investors and CPAs, in Tax Strategies for the Savvy Real Estate Investor. Pick up your copy from the BiggerPockets bookstore today!

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Do you have a Roth IRA? Would you ever use it to purchase real estate? Why or why not?

Discuss in the comment section below!