Investing in real estate can provide a great opportunity for IRA owners to diversify their retirement portfolios. However, owning and buying real estate in an IRA requires careful consideration and adherence to IRS regulations. Only a special IRA called a self-directed IRA may invest in real estate. In this article, we’ll break down four considerations for staying compliant with the IRS while investing IRA funds in real estate.
Unrelated Business Income Tax and Form 990-T Filing Requirements
When an IRA invests in real estate, it must comply with IRS regulations regarding unrelated business income tax (UBIT). UBIT is a federal income tax on income generated from a trade or business that is unrelated to the IRA's tax-exempt status. Real estate investments can generate UBIT if the rental real estate property is leveraged or if the IRA participates in activities beyond passive rental income. If an IRA generates UBIT, it must file Form 990-T, Exempt Organization Business Income Tax Return. The IRA owner is responsible for ensuring that the IRA files Form 990-T and pays any taxes owed.
Reporting Disclosures on K-1
If an IRA invests in a partnership or LLC that owns real estate, the IRA may receive an annual K-1 Form that reports the IRA's share of the partnership's income, deductions, and credits. The IRA owner is responsible for reporting this information on their Form 990-T, as noted above.
It's important to understand the UBIT rules and how they apply to your real estate investments to avoid any surprises come tax time. IRA’s tax-exempt status generally means they’re not entitled to bonus depreciation.
Required Minimum Distribution Rules
Required Minimum Distribution (RMD) is the minimum amount that an IRA owner must withdraw from their account each year once they reach the age of 72 (expanded to 75 based on your year of birth). These distributions are taxed as ordinary income and are calculated based on the IRA owner's life expectancy and the total value of their IRA accounts.
When it comes to investing IRA funds in real estate, RMD rules can be a bit tricky. If the real estate is generating rental income, that income is subject to RMD calculations just like any other IRA investment. However, if the real estate is not generating any income, the IRA owner may have to take distributions based on the appraised value of the property. If an IRA owns real estate, the IRA owner must determine the fair market value of the property each year and take a distribution based on that value. This could be challenging if the IRA owes equity in a partnership. The partnership is often not positioned to opine on the RMD calculation, so there is an added layer of complexity for these IRA owners/investors.
Form 990-T Filing Responsibility
Finally, IRA owners must determine who is responsible for filing Form 990-T if the IRA generates UBIT. The IRA custodian or trustee may offer assistance with filing Form 990-T, but ultimately it is the responsibility of the IRA owner to ensure compliance with all IRS regulations.
Let Us Guide You Forward
Investing in real estate with IRA funds can be a smart move for retirement savings, but it requires careful attention to IRS regulations. IRA owners must be aware of UBIT, K-1 reporting disclosures, RMD rules, and Form 990-T filing responsibilities. By working with a knowledgeable tax professional and staying informed about IRS requirements, IRA owners can maximize returns from their real estate investments while staying compliant. With the right approach, real estate can be a valuable addition to any IRA portfolio.
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