Why Physical Real Estate May Not Belong in Your IRA

For many investors, real estate is a cornerstone of building wealth. It provides potential appreciation, steady rental income, and diversification outside of traditional stock and bond markets. But when it comes to retirement accounts like IRAs, directly owning physical real estate often creates more headaches than benefits.

Before we dive into why, let’s acknowledge what makes real estate powerful in the first place.

The Power of Real Estate Ownership

Real estate can be a highly effective wealth-building tool for several reasons:

• Cash Flow: Rental income can provide steady, inflation-resistant income streams.
• Appreciation: Over time, real estate has the potential to grow in value, helping build equity.
• Leverage: Mortgages allow investors to control a larger asset with less upfront capital, magnifying returns when property values rise.
• Tangible Asset: Unlike stocks and bonds, real estate is a physical asset with intrinsic utility.

And perhaps most importantly—

Real Estate’s Tax Efficiencies

Owning real estate personally comes with powerful tax benefits:

• Depreciation deductions can offset rental income.
• Mortgage interest and expense deductions reduce taxable income.
• 1031 exchanges allow you to defer capital gains by rolling proceeds into another investment property.
• Step-up in basis at death can potentially eliminate capital gains for heirs.

These advantages are a big part of why real estate has historically played such a strong role in wealth creation. Unfortunately, many of them don’t apply when real estate is owned inside an IRA.

Why Real Estate in IRAs Often Falls Short

1. Strict IRS Rules and Penalties

If you personally benefit from the property—by staying in it, renting it to a family member, or even performing maintenance—you could trigger a prohibited transaction. That mistake may cause the entire IRA to become immediately taxable, along with penalties.

2. Limited Access to Cash Flow

Rental income must remain in the IRA. You cannot use it until you take distributions, and distributions may be taxable. If you hoped for current income, this structure doesn’t help.

3. Maintenance and Liquidity Issues

All expenses must be paid from IRA funds. If the account doesn’t have enough cash, you may be forced to sell the property or scramble for contributions, which are subject to annual limits.

4. Loss of Tax Benefits

The biggest drawback: none of the powerful tax benefits mentioned earlier apply. Depreciation deductions, 1031 exchanges, and other strategies are off the table. You only get the IRA’s tax treatment, which may not be as advantageous for real estate.

5. UBIT Exposure

If leverage is used, income and gains may be subject to Unrelated Business Income Tax (UBIT), creating unexpected bills inside your IRA.

6. Concentration Risk

Tying up retirement savings in one illiquid property can reduce flexibility, especially when required minimum distributions (RMDs) begin. IRS RMD Rules

The Bottom Line

Real estate is a proven wealth-builder, thanks to its income potential, appreciation, and tax efficiencies. But those benefits largely disappear inside an IRA, while new risks and compliance issues are introduced.

For most investors, it makes more sense to hold real estate outside of retirement accounts, where you can use the full suite of tax advantages. Inside IRAs, more traditional investments—like REITs or funds that provide real estate exposure—may offer a simpler, more liquid way to diversify your portfolio.

Disclosure: This content is for informational and educational purposes only and should not be interpreted as financial, legal, or tax advice. While we strive for accuracy, we do not guarantee the completeness or reliability of the information provided. Investment decisions should be based on individual circumstances, and we recommend consulting a qualified professional before implementing any financial, legal, or tax strategies. Past performance is not indicative of future results, and all investments carry risks, including potential loss of principal. No investment strategy can guarantee success or protect against loss in all market conditions. Investors should carefully consider their risk tolerance, investment objectives, and financial circumstances before making investment decisions.