Thinking of buying a vacation home with IRA Funds? 

Watch out for higher fees when purchasing a vacation home in a self-directed IRA

I listen to you every Sunday morning on WGN and I have a question. I’m thinking of buying a vacation home with IRA funds. Can I do that?

A: The short answer is maybe. But there are several questions to answer and issues to think through before you write an offer. They include how old you are, what type of IRA (Investment Retirement Account) you have, and what exactly you mean by the phrase “vacation home.”

Vacation Home vs. Real Estate Investment

First, what does “vacation home” mean to you? A second home where you’ll spend weekends and your own vacation time? Or, a home that you intend to rent out at least some of the time, or when you’re not there?

When it comes to the tax code, there’s a big difference between a home you intend to use for your own recreation (or your family’s or friends’) and a home that you buy in a popular vacation spot that you intend to rent out the vast majority of the year either through a platform such as Airbnb or VRBO. If your home is a true vacation property, one that the IRS considers to be owner-occupied, and will not become an investment, then you cannot use your IRA funds to purchase that property.

Leverage IRA funds to buy a first home

Of course, there is an exception to this rule. Let’s say you rent in a city and want to buy your first home. But, buying a home in your city is out of reach. Instead, you think about buying a vacation property as your first home. If your vacation property is actually a first home, you may withdraw up to $10,000 penalty-free, according to the IRS.

Penalty-free doesn’t mean tax-free, however. You’ll still have to pay tax on the amount you withdraw. Your $10,000 might only net between $7,000 and $8,000, depending on your tax bracket. But, if you’re scrounging around for down payment cash, every little bit helps.

Withdraw IRA funds penalty-free if you’re over 59 1/2

Of course, if you’re over the age of 59 ½, you can withdraw any amount of funds you need to purchase the property. Just remember that you’ll pay tax on that withdrawal, which could boost your overall tax liability. The question for you to ponder: Should you spend your retirement funds on a vacation home? Investment advisors generally advise against making withdrawals such as these because it reduces your retirement kitty just as you’re nearing retirement.

But if that’s what you want to do, there’s nothing to stop you from using withdrawn, post-tax IRA funds as you please.

Self-directed IRA funds can be used to buy an investment vacation home

What if the vacation home is actually an investment property? Or a mix of vacation and investment? “IRA law does not prohibit investing in real estate, but trustees are not required to offer real estate as an option,” according to

So, most of them don’t. Most of the financial services companies that offer IRAs limit what can be bought with your IRA funds. Typically, you can invest in individual stocks, bonds, mutual funds (managed, index, ETFs, and other types), and real estate investment trusts (REITs). If it’s traded on a major stock exchange, you can use your IRA funds to make an investment.

Some financial services companies are now allowing, or are planning to allow, customers to make investments in crypto currencies, and other alternative investments. But for the most part, traditional financial services companies do not allow you to purchase real estate with IRA funds.

Self-directed IRAs charge higher fees to use IRA funds to buy a vacation investment home

But there is another type of IRA that will. A self-directed IRA, which may also be known as a real estate IRA, will allow you to purchase investment properties. Title to the property will be held in the name of the IRA (not personally). All rental income will be paid into the IRA. Any expenses will be paid out of the IRA. IRS rules say you cannot use the house personally. There are two exceptions:

  1. You can stay in the property for no more than 14 days per calendar year
  2. Or, you can stay in the property for up to 10 percent of the total number of days it is rented 

Keep in mind that if you run afoul of the IRS rules relating to IRAs, you could find yourself paying taxes and penalties on the IRA funds you used to buy the property. We have never been big proponents of using IRA funds to buy real estate. It’s complex, cumbersome and could be expensive.

Self-directed IRA real estate: You may not be able to use a 1031 Exchange

Think about it. If you use IRA money, which as a qualified retirement account defers the payment of taxes, you may not get the full benefits of owning investment real estate. For example, you may not get the full tax benefit of depreciating the property or deducting the expenses. You won’t get the full benefit of using a tax deferred exchange to sell this investment property to buy another using (Section 1031 of the Internal Revenue Code). And, you won’t get the stepped up basis on the value of the property when you die.

If you look, you’ll find quite a bit of information that discourages the use of IRA money to buy investment real estate.

Research self-directed IRA companies carefully

If, however, you still want to do this, you should interview several top self-directed IRA companies. Then, arrange for an IRA “trustee-to-trustee” transfer of funds from your traditional IRA to your new self-directed IRA account. Understand that fees may be higher for a self-directed IRA account than a traditional IRA. Be sure to get all of your questions answered before proceeding.

If you have a Roth IRA, you may withdraw contributions at any time after five years without paying tax or penalties. You could use this money to pay for a house. If you’re buying your first home, you and your spouse may each withdraw up to $10,000 in Roth IRA funds from your respective accounts.

The IRS will allow you to use your investment property for up to 14 days of personal use without turning it into a personal residence. IRS Tax Topic No. 415, Renting Residential and Vacation Property states that if you receive rental income from a property, you may deduct certain expenses (including mortgage interest, real estate taxes, casualty losses, maintenance, utilities, insurance, and depreciation), which will reduce the amount of rental income that’s subject to tax. Just be aware that your IRA won’t have the ability to deduct these expenses.

Thanks for listening to Ilyce’s show, This Week in Wealth. You can find past episodes of the show here.

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