Should I Use Retirement Funds to Invest in Real Estate?

Posted By: Chris Tanner ICOR Blog & News ,

Self-Directed retirement plans allow individuals to invest in real estate, but are retirement funds the best option? The answer varies and depends on what type of investing you are involved with. In addition, there are tax considerations that one needs to evaluate before making a final decision. Like most things in life, real estate investing with a self-directed retirement plan has its pluses and minuses. Let evaluate some common scenarios and look at whether using retirements funds makes sense or not.

Fix n Flips and Wholesaling – Using retirement funds is typically not advantageous for these investments, and here’s why. When real estate is bought and sold within a one-year period it is subject to short term capital gains. Unfortunately, self-directed retirement plans are also subject to short term capital gains in this scenario. This means one would be paying tax twice on the same money. In addition, the IRS may view fix n flipping and wholesaling as active businesses and running an active business from within a retirement plan may subject it to unrelated business income tax.

Long-term holds and Private lending – These tend to be better suited for retirement funds, and here’s why. Passive income from rents and debt payments are not subject to taxation from the IRS. Let me elaborate. If one invests using a Roth account, the earnings grow tax free, and they can likely be taken out tax free when certain requirements are met. If one invests using a tax deferred account, like a Traditional IRA, the earnings grow tax free until the account owner takes a distribution. Distributions are taxable at the ordinary income rate, but the IRS allows these types of accounts to grow tax free, and they often allow people to reduce their taxable income by making contributions to these accounts.

High income earners – These folks need to evaluate the importance of the deductions real estate investing provides before choosing to use personal or retirement funds. Real estate is one place in the tax code that allows for some attractive tax deductions. The IRS allows for expenses like property insurance, mortgage interest, repairs, property taxes, etc… to be used to offset income. The IRS also allows depreciation, which can also be used to offset income. For high income earners, these types of tax deductions can assist in lowering their taxable income. When investing with retirement funds, the IRS does not allow these deductions. Why? You must choose. The IRS does not allow tax sheltered plans the best of both worlds. They don’t allow BOTH tax free growth AND the ability to deduct expenses and depreciation. This means an individual needs to decide which is more important, tax free growth with no deductions, or taxable income that allows for deductions.

If you’re debating whether to use retirement funds for your real estate investments, we encourage you contact a member of our business development team to evaluate your situation.