Pros & Cons of Real Estate Funds in an IRA
You can invest in nearly any kind of real estate using a self-directed IRA, but there are significant IRS restrictions on these types of real estate transactions. Running afoul of IRS rules can mean a significant penalty, so it's best to know all your facts before you start including real estate as part of your retirement account savings.
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Pro: Buy Any Real Estate You Want
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There are no restrictions on the amount or type of real estate you can invest your IRA funds in. Domestic or international, residential or commercial, single-family or multi-unit, one property or 100--the choice is up to you. You can also buy land (without any construction on it) or vacation property with your IRA.
Pro: A (Potentially) Safer Investment
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If you buy a plot of land or a home with the intention of using it as a retirement home, and you wait until you are 59-1/2 to begin building on it or living in it, then you are free to live in and enjoy the property for the remainder of your life. For some people, owning property is a safer and more tangible way of investing retirement funds than having money in stocks or mutual funds.
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Pro or Con: Costs
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The financial institution administering your self-directed IRA will still charge you a fee; typically 1 percent of the value of the IRA each year. Depending on the value of the real estate you purchase, you may want to shop around for a flat-fee self-directed IRA to avoid having to pay increasing annual fees as the value of your property increases.
Con: Self-Directed IRAs Mean More Work
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The only way to invest in real estate using an IRA is through a self-directed IRA, which means you personally control exactly how the funds in your IRA are spent, just as you control how the funds in your checking or savings accounts are spent. This is in contrast to more common IRAs that are handled by a financial institution where professionals oversee your IRA account and manage stocks and mutual funds that your IRA is invested in.
Con: You Cannot Live on or Use the Property You Invest in
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Similar to how you cannot withdraw funds from an IRA before you're 59-1/2 (as of 2009) without incurring an early withdrawal penalty, you also cannot derive personal benefit from the real estate you invest in with your IRA funds until you are 59-1/2. This means you could buy a home or a plot of land with the intention of retiring on it, but you cannot live or vacation in that home (or start construction on that plot of land) until you are old enough to make penalty-free IRA withdrawals. Even a weekend camping trip on your plot of land could land you in hot water with the IRS if they find out about it. It's also against the rules to let friends or family members rent, live in or vacation in these properties.
Any money earned from renting or selling this property must be put directly into the IRA used to pay for it; you cannot earn money directly from this property without incurring an early withdrawal penalty.
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