Few investors realize that the IRS has always permitted real estate to be held inside IRA retirement accounts.
There's no telling if we've finally reached rock bottom with home prices, but the numbers are beginning to look a little better. Demand seems on the rise – especially for distressed properties on the low end of the market.
The big players of the hedge fund and private equity world are also diving into the market with all the cash they've been hoarding over the last few years.
The Oracle of Omaha himself, Warren Buffett, told CNBC last month:
"Equities are still cheap relative to any other asset class — but they're not — I would say single-family homes are cheap, too… Single-family homes. If I had a way of buying a couple thousand single-family homes and had a way of managing them, the management is a problem because they're one by one not like apartment houses.
"But I would load up on them and I would take mortgages out at very low rates. If anybody is thinking about buying homes, five years ago they couldn't buy them fast enough. Interest rates are far lower.
"It's a way, in effect, to shorten the dollar. You can take a 30-year mortgage. You can refinance lower. If it's too low, the other guy is stuck with it for 30 years. It's an attractive asset class now."
Is there any way those of us who don't have a couple of billion dollars lying around can take advantage of this market? The answer may be an Individual Retirement Account (IRA).
IRAs as vehicles to get real estate income
There's something to Buffett's statement. Look at it this way: There's a strong rental demand and relatively little supply of single-family homes, and it could be far less risky than the stock market. Unlike four or five years ago, you're not looking for the home to appreciate in value. Your return is coming from rent.
Now self-directed IRAs are the accounts most of us are accustomed with. Most people mistakenly believe that their IRA must be invested in bank CDs, the stock market, or mutual funds. Few investors realize that the IRS has always permitted real estate to be held inside IRA retirement accounts.
Keep in mind that all firms acting as he custodian of your IRA don't offer the ability to hold property and deal with all associated expenses. This will require a little research.
The property can only be used purely as an investment, with all the income going directly back into the IRA. The owner may not occupy the home or even use it as a second home. The owner can manage the property, doing maintenance and supervising the renting, or can hire a rental management company, which would be paid for out of the IRA.
Special Treatment of Income
There are two different types of IRAs where which this is possible:
- Tax-deferred – These are the traditional IRAs that allow yearly contributions to a tax-deferred account with pretax dollars. Your IRA contribution isn't taxed and you won't be taxed until you redeem the money when you retire.
- Tax-free – These are tax-free retirement accounts. Also known as the Roth IRA, yearly contributions are made with after-tax dollars. These offer no tax advantage in the year the contribution is made because the Roth IRA contribution isn't deductible. The advantage is that earnings grow tax-free, as well as the withdrawals when you retire.
The Roth IRA maybe more advantageous for real estate investment because all income and gains resulting from real estate transactions would be tax-free. Yet most people have the traditional IRA. Although the income from the traditional IRA isn't "tax-free", it is "tax-deferred."