elf-directed IRA papers on desk

How to Invest in Real Estate with a Self-Directed IRA

Self-Directed IRAs are great ways to buy real estate by tapping into your retirement nest egg. If you have a 401(k) you will have to roll that investment vehicle to a Self-Directed IRA before you can use those funds to purchase real estate. Below is a thumbnail sketch of this Investment Strategy. I encourage anyone interested in this approach to talk with your financial advisor, CPA, and attorney.

With a Self-Directed IRA you can purchase single-family, multifamily, apartments, commercial properties, raw land, and other types of real property. While not as easy as buying shares of a mutual fund on your retirement brokerage’s platform, it is easy enough if you know the rules and can navigate those properly.

It Must Be A Self-Directed IRA

Before you can do anything, you must first have a Self-Directed IRA. Alternative forms of investments are allowed under this type of investment vehicle. (Alternative forms of investment for purposes of this blog post means real estate.) A self-directed IRA is independent of a brokerage, e.g. Schwab or Fidelity, etc., so the restrictions that generally preclude investing in real estate are not hindering you from now investing in that apartment building you have had your eye on.

In order to buy real estate you must have a custodian, which is an entity that specializes in self-directed accounts that will manage the transaction, paperwork, and financial reporting compliance. The custodian is your gate-keeper and protector to keep you between the lines and away from any rule violations. These custodians charge a fee for their administrative service.

Of note about this type of property purchase is that you don’t actually own the real estate- your Self-Directed IRA does. Real estate purchased through a Self-Directed IRA will be titled “ABC Trust Company Custodian FBO Jane Doe IRA.”  Thus, the property is not titled in your name, but in the name of your IRA since it is an asset of your new Self-Directed IRA.

Qualified vs. Disqualified

Critically important to know about the property is that it cannot be your vacation home. It MUST be held purely for investment. This is true even for your family who are considered by the IRS as “disqualified persons.” The following is a list of those “disqualified persons.”

  • Your Husband or Wife
  • Parents, Grandparents, and great-grandparents
  • Children and spouses, grandchildren, great-grandchildren
  • Any service vendor to your IRA
  • Any entity that owns more than 50% of the property

Additionally, you CANNOT buy from these people either. They are “disqualified” in every sense of the word for this investment vehicle. Should you buy from one of these individuals, you will get flagged for self-dealing. Violating this cardinal rule of Self-Directed IRA ownership could subject your entire Self-Directed IRA funds to immediate taxation.

Buying The Property

It is important to know that Self-Directed IRAs have a difficult time obtaining mortgages. So, most investments will be cash purchases or investments. Make sure to factor this into your rate of return when analyzing a deal.  Leveraging deals gets tricky and oftentimes not possible thereby impacting your return on investment.

If you can find a bank to finance a deal for you, it is important you speak to your CPA about §511 of the Tax Code. This particular section of the code is related to unrelated business taxable income (UBTI). The revenue from this property could fall into the purview of this code section.

No Deductions

A Self-Directed IRA is not taxed. If the entity is not taxed, it logically follows that the entity cannot take deductions. One of the lures to owning real estate, in my opinion, are the tax benefits of ownership. This tax benefit is all but eliminated by the use of the Self-Directed IRA. In short, there is no depreciation, no interest deduction, no property tax deduction, no maintenance deductions, etc.

The bright side to this ugly truth is that you don’t have to pay for the associated costs of ownership. Your IRA will pay for all of those costs. But, what happens if the IRA doesn’t have enough funds to cover those costs? Unfortunately, you cannot pay for those out of pocket. Instead, you have to contribute to the IRA and if you have exceeded your contribution amount for the year, you will have to incur the penalties associated with that contribution.

Selling The Property

All sales of the property are conducted through the custodian. Any funds received will go back into your IRA tax-deferred or tax-free, depending on your IRA’s constitution. As with most property sales, it is never fast. Bear that in mind as you consider this type of ownership.

There are benefits and drawbacks to this type of ownership. It is not for everyone. In fact, there are some people who have completely liquidated their 401(k)s and other investment vehicles to take the penalties and taxes so they are free to use the remaining funds more freely. You will need to read more about Self-Directed IRAs to understand the details more fully. Also, speak with your investment advisor, CPA, and Lawyer.

Disclaimer: The views and opinions expressed in this blog post are provided for informational purposes only, and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action.

Follow Me:  
FacebooktwitterlinkedinrssyoutubeinstagramFacebooktwitterlinkedinrssyoutubeinstagram


Share this:  
FacebooktwitterpinterestlinkedinFacebooktwitterpinterestlinkedin

You may also like

Leave a comment

Joe Fairless