Learn how you can increase returns and diversify your portfolio while complying with IRS guidelines.

Individual retirement accounts (IRAs) are great for growing your investment assets on a tax-deferred basis. Although Americans generally use their IRAs to invest in U.S. stocks, bonds, and mutual funds, the tax code doesn’t place any restriction on where the investment assets can be located.

Yet, most Americans retirement accounts aren’t benefiting from international investment and global diversification simply because it’s not profitable for brokerage houses to offer such options.

Investors who want to build a more diverse portfolio can use their IRA funds to take advantage of high-yield opportunities overseas, such as real estate investments. If you choose to do so, it’s important to understand the IRS’s rules so you can set up your investments correctly. 

What You Can and Can’t Do When Using Your IRA to Invest Overseas

First of all, you can use your IRA funds to invest outside the United States. These include SIMPLE IRA, traditional IRA, SEP IRA, Roth IRA, individual 401(k), ESA, and HSA accounts. You can use the funds to purchase any asset—such as real estate, stocks, bonds, and mutual funds—just as you do within the U.S.

Three major types of assets can’t be held in an IRA – investments in life insurance contracts and “collectibles,” as well as U.S. operating companies (as opposed to a passive investment), because it will attract Unrelated Business Income Tax (UBIT).

Otherwise, you have quite a bit of liberty to choose your investment vehicles. Just be sure to adhere to the “no self-dealing” rules, which means you can’t buy or sell something from or to your IRA personally, nor use any asset that your IRA invests in. For example, you, your spouse, or your children can’t live in a property purchased with funds from your IRA.

The Benefits of Investing in Foreign Real Estate with Your IRA

Purchasing foreign real estate allows you to diversify your portfolio. It also protects you from the risk of putting all your (nest) eggs in one basket (i.e., the U.S. economy) because the investment isn’t linked to the U.S. dollar or markets. Also, only real estate located in Canada, the UK, and France can be seized by the IRS.

In addition, many foreign real estate investments have lower investment minimums and management costs while yielding higher returns compared with U.S.-based options.

How to Invest Overseas with Your IRA

Here’s how you can take advantage of foreign real estate opportunities or other investments while adhering to the rules of the IRS:

1. Move Your Funds to a Custodian That Handles International Transactions

Most U.S. brokerage houses that manage IRA funds don’t deal with foreign transactions. Since they make money from handling your investments, you might encounter resistance if you make a request to move your account. 

If you can, it’s better to work from the start with a firm that specializes in foreign transactions. Your first step is to transfer your IRA funds (not rollover) to the new custodian. You can make as many transfers from one custodian to another as you like without any tax consequences.

2. Decide the Best Way to Hold the Investment

There are two ways you can hold your foreign investment, and you need to decide which one will work best for your circumstances. If you’re only making a single transaction, it’s cheaper and less complicated to invest as a self-directed account through your custodian. However, if you plan to make multiple investments or want to maximize asset protection and diversity, consider setting up an offshore IRA LLC.

Investing as a self-directed account through your custodian

A self-directed account means you can “direct” the custodian to make specific investments. As such, you need to select a custodian that’s willing to make a foreign investment on your behalf. These custodians typically charge an annual fee for the custodianship and compliance work they do for you, which is not based on the transaction amount.

The custodian has the right to refuse to make the purchase if they don’t think it’s in the best interests of the IRA. Some might also refuse to do so because they can’t perform the due diligence required. If any of the many IRA rules are broken, or the investment goes bad, they could face liability issues.

Setting up an offshore IRA LLC

If you set up an IRA LLC, the custodian makes only one investment by transferring your IRA funds into the IRA LLC’s bank account. From there, you make the investment decisions and are, therefore, responsible for all the decisions, responsibilities, and liabilities.

If you do so, make sure that you’re following all of the IRS’s rules including the following:

• Don’t borrow against the IRA LLC, don’t receive personal benefits from the investment, and always make decisions that are in the best interest of the IRA LLC.
• You can’t purchase a real estate property with your IRA funds and live in it—or even rent it to yourself at a fair market price for any duration—because it would break the rule against “self-dealing.”
• You can’t personally guarantee a loan, so if you buy with a mortgage, it must be a non-recourse loan in which only the property may be used as collateral.
• If you buy real estate overseas with a mortgage, you should set up an offshore UBIT (Unrelated Business Income Tax) blocker to avoid paying U.S. taxes on the gains and rental income generated by the property.

3. Handle Ongoing Management and Reporting

The corporate entity (i.e., the IRA LLC) will need to report back to the IRA custodian on the change in the investment’s value. The custodian is then responsible for regularly communicating those values to the IRS to ensure proper compliance with all tax laws.

Optimize Your Foreign Real Estate Investments

To take advantage of investing in overseas real estate with your IRA while minimizing the risk and hassle, you should work with an experienced manager who engages in extensive due diligence for evaluating acquisitions and boasts a high-quality real estate portfolio. This will allow you to choose investments that align with your risk tolerance and time horizon. 

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