How to Use Retirement Funds to Buy Real Estate
Are you considering using your retirement funds to buy real estate? Whether it's for an investment or for your primary residence, here are things that you should know.
If you have been wanting to enter the real estate investment market but are struggling with the money side of things, there is one method that can help build capital. Your retirement fund, better known as an IRA (individual retirement account). If you have been working for a number of years and contributing to your IRA, then you could be in luck, and be able to use some of your hard-earned retirement savings to buy real estate. This is perfectly legal and very possible, and we will find out how.
Table of Contents
- What are you able to purchase with your retirement funds?
- What are some of the rules with using your retirement to purchase real estate?
- What are some downsides of using your retirement funds for purchasing real estate?
- Steps to purchasing property with your retirement finds
What are you able to purchase with your retirement funds?
Many people choose to invest using their retirement funds and investing in real estate is one very good way to do this. There are certain restrictions to what exactly you can purchase with your retirement funds. However, most of the standard real estate purchases are included. These are listed by Investopedia as being the following:
- Single family homes.
- Multiplex homes
- Apartment buildings.
- Commercial properties (retail stores, hotels, office complexes).
- Raw land and lots.
- Boat slips.
Another important thing to remember is that any real estate you purchase with retirement funds needs to be for investment only. You cannot purchase a house for the sole purpose of you to reside in. Your immediate family and spouse are also not allowed to reside in such property either.
What are some of the rules with using your retirement to purchase real estate?
You may be surprised to hear that there is a whole list of rules when it comes to using your retirement to purchase real estate. Although it is your money, the tax man views your retirement money differently to money from a standard account. Retirement funds when left alone are not taxed, however The Balance explains that if you buy real estate improperly, you can disqualify your retirement funds and make them taxable. Which would end up extremely expensive. So, in order to avoid this, certain rules need to be met.
- You cannot mortgage the property. You will need to purchase any real estate in cash, which could limit what you are able to afford.
- You cannot work on the property yourself. No DIY. All maintenance and renovation work must be paid for by an independent contractor.
- All costs associated with the property have to come out of your retirement funds. So, after the initial purchase you need to make sure that there is enough money left over to cover any expenses that may come up.
- You cannot live in the property or use it in any way for your personal benefit. This includes storage of personal property.
What are some downsides of using your retirement funds for purchasing real estate?
While it may seem like an amazing idea to use money that you are not even using yet to purchase an investment, you need to be aware that there are some downsides. Which is why the experts warn that you need to gain sound financial advice and be absolutely sure that the decision is right for you. All investments carry risk; however, most investments do not risk your retirement. By using your retirement funds, you are using money that you will need in the future once you stop working. If your investment ends up bad, you could be ruining your future.
One thing that many people may not expect is that not only do all costs need to come out of your retirement fund account, but all income needs to go straight back in. So, if you rent out the property and make a profit, then you cannot use this profit until you are of retirement age and can access the funds. So even if you manage to make a really savvy investment purchase, you will not be able to realize the benefits until you are of retirement age. And a lot can happen between then and now.
Steps to purchasing property with your retirement finds
Once you are sure that using your retirement funds for purchasing real estate is a good idea, then you will want to know ow to get started. These are highlighted by Millionacres.
Ensure you hold the right type of retirement IRA account
You will need a special type of retirement account in order to purchase real estate These are known as a self-directed IRA and are offered by specialized firms. If your retirement is currently through a brokerage, then you will need to change this.
Ensure you meet the restrictions
The main rules and restrictions were highlighted earlier, so you need to ensure that you are meeting them. The biggest being that you cannot purchase for yourself or a family member to live in, and you cannot purchase from yourself or a family member.
Find a property you can afford
This is one of the most important steps and is where many people will get into trouble. Because all expenses need to be paid out of your retirement fund (including the purchase of furniture if you want to have a furnished rental property), you need to ensure that you have several months’ worth of ownership expenses in your account as a minimum. Otherwise, your investment can end up costing you a lot more than you expect.
Consult an experienced tax professional
Tax is complicated, and so is the process of using your retirement funds to purchase real estate. Any mistakes can end up very costly from hefty tax bills and IRS penalties, so it is important that you consult a professional to ensure that the purchase is conducted properly.
While it is very possible to use your retirement funds to purchase real estate, it is understandably quite complex and complicated. There are many rules and restrictions, however if you have enough money in your IRA to justify the cost, then using it for an investment could really set you up in your future.
Charles is the founder of infoSpike.com. His real estate investing experience started in 2004 and he is currently focused on rental property projects. He enjoys learning about real estate investing, personal finance, and marketing. Read more about Charles here.