An IRA is a powerful financial planning tool that allows you to save for retirement, or provide benefits for your heirs, on a tax-advantaged basis. Most people invest their IRA funds in stocks, bonds and mutual funds. But others opt for nontraditional investments, such as real estate, in the hope of boosting their returns.

If you choose to hold real estate in your IRA, be aware that there are several tax traps for the unwary, chief among them the prohibited transaction rules. Those rules disallow certain dealings between you (or your beneficiaries) and your IRA.

For example, you and your beneficiaries can’t sell or lease property to your IRA, buy or lease property from your IRA, use IRA property as a personal residence or office, lend to or borrow from your IRA, guarantee a loan to your IRA, pledge IRA assets as security for a loan or provide goods or services to your IRA. This last prohibition means you can’t provide property management, renovation or construction services, either by yourself or through a family member or a company you control.

Violations of the prohibited transaction rules result in termination of the IRA. That means you’ll be liable for taxes and penalties on the entire account balance, regardless of the transaction’s size.

Other considerations to keep in mind:

• In a traditional IRA, any capital gains eventually will be taxed as ordinary income.
• If real estate is financed by a mortgage, some income may be subject to unrelated business income tax (UBIT).
• Not all IRA custodians permit real estate investments, so you may have to open a self-directed IRA.
• If you have a traditional IRA, it must have sufficient cash or other liquid assets to fund required minimum distributions starting at age 70½.