What Is a Self-Directed IRA Real Estate Investment (and Should You Do It)?

What Is a Self-Directed IRA Real Estate Investment (and Should You Do It)?

Why would you buy real estate in your IRA? The biggest benefit of a self-directed IRA real estate investment is the awesome opportunity for your money to grow…tax-deferred!

Be it a rental, fix-and-flip, or raw land, if you think you can make money, you can buy it. Then you can legally avoid paying taxes on any gains (such as appreciation, rental income, and amortization).

Read on to learn everything you need to know about how and if you should buy property in your self-directed IRA.

Why must the IRA be “self-directed”?

Basically, “self-directed” means that you can invest in “alternative investments.” These types of investments include real estate, notes, precious metals, start-ups and even cryptocurrency.

A self-directed IRA (SDIRA) needs to have a custodian. All your transactions will go through the custodian to keep you from violating any real estate specific IRA rules.

Self-directed IRA custodians must be approved by the IRS. Check out this IRA list of approved nonbank trustees and custodians. 

What kind of taxes do I have to pay if I hold real estate in my IRA?

The answer is none. The property is considered an asset of your retirement fund, and thus is tax deferred until you reach retirement age. If you have a self-directed Roth IRA, then you're tax free forever.

What kind of property is my SDIRA allowed to buy?

There are no limitations. If you find a piece of real estate that you think can make money, be it as a rental, fix-and-flip, or a straight up investment, you can purchase it for your IRA.

*Note: If you utilize your IRA to flip more than a couple properties a year, you should consult your tax lawyer or CPA on the exact details of your IRA's investments. In this case, you could incur unrelated business income tax.

You can also purchase property internationally, like we did in Belize. This is a great reason to utilize your SDIRA, because you may not get as many tax benefit from International property anyway. You can buy raw land, a condo, a house, or an office building.

Foreign real estate in a self-directed IRA is a bonus because it gives you an asset that can’t be seized and whose value is not linked to the US dollar or the US stock markets.

Can I live in my property after I buy it?

No. You can't live in it or use it in any way, until you retire. It is strictly for investment.

In addition, you family members cannot live in it. If you buy a property from or sell a property to a family member (or yourself), you will disqualify your IRA. (“Family member,” however, does not include siblings, aunts, uncles or cousins.)

Furthermore, you can't receive any indirect benefit from the property. For instance, you can’t be the property manager. You can't even hire a family member to be the property manager!

Can I just make a down payment with my IRA funds and use a mortgage to pay for the rest?

Yes, but you have to use a non-recourse loan. That means that the lending institution has no recourse to the individual borrower, and instead guarantees the loan with the property itself. The reason why you have to use a non-recourse loan is so that you don't give any personal guarantees for your IRA. Giving a personal guarantee would constitute a Prohibited Transaction.

Can I provide additional funds to my IRA with existing cash?

Yes. This strategy is not well known, but you can fund your account with existing cash. The IRS does penalize you 6% for excessive contributions, but it may still be worth it, depending on your circumstances.

How do I get started?

Start by finding a financial institution to act as your custodian. When looking into custodians, do your due diligence and check out their fees and their rating with the Better Business Bureau.

Then, complete your SDIRA application and pay any application fees.

Once the IRA is set up, you have to fund your account. You may make a one-time contribution or choose to set up an automatic investment plan.

When you're ready to purchase a property, you'll file your paperwork and purchase assets through your SDIRA custodian.

Alternatively, you can save money on processing fees by establishing checkbook control.

The way the checkbook control works is through an LLC (Limited Liability Company.) You set up a dedicated LLC for your SDIRA and you appoint yourself as its manager.

After you appoint yourself, then you will open a checking account at the bank of your choosing in the name of the LLC. Following that, you can place real estate in your SDIRA by simply writing a check from the LLC's checking account.

Can you recommend a good custodian company?

Sure. When I didn't have cash available for a property deal in Ambergris Caye, Belize, I decided to utilize a self-directed IRA. I had to open an account and then rollover the funds from our existing IRAs into it. Then I worked with the SDIRA company, Equity Trust, and they sent in the funds directly for the closing. I recommend them.

But again, always do your own research and check out their fees and their rating with the Better Business Bureau.

What happens if I want to sell the property?

Just go ahead and sell it. The proceeds from the sale are deposited back into the self-directed IRA (or in the case of checkbook control, the LLC's checking account, thereby becoming part of the IRA's assets).

What about using a self-directed 401K instead?

If you are self-employed, you might consider buying property through your self-directed 401K instead. Solo 401k’s have MUCH higher contribution limits, when compared to IRAs. A self-employed person can put away up to 57K per year, as of 2021. An IRA maxes out at 9K.

>>Related Post: What Is a Self-Directed 401k?

What are the benefits of self-directed IRA real estate investment?

Tax-deferred income

When you use your self-directed IRA to purchase real estate, your income is tax-deferred until the day you take withdrawals. Or, if you utilize a Roth IRA, you can withdraw your gains tax-free.

You can buy and sell properties to your heart's content, all while maintaining your tax-deferral status.

Real estate has historically appreciated over time

Real estate is a great investment.

Through a combination of residential and commercial “buy & hold” investments, inclusive of my residences, I’ve achieved a weighted average return of over 40% per year on invested capital, with reinvested gains.

>>Related Post: The 5 Critical Components of Real Estate Investing Returns

Diversify your portfolio outside of stocks

The stock market is volatile, and tricky to understand. Real estate, on the other hand, is simple to understand. When you look at a property, you are familiar with what makes a home good or bad. It's much easier for the average person to understand exactly what they are investing in.

Furthermore, if you are looking for a steady stream of income, housing is a good bet. People will always need places to live, no matter what.

What are the negatives of self-directed IRA real estate investment?

You might miss out on bigger tax benefits.

If you are planning to buy an investment property to use as a rental, you might not want to buy it through your self-directed IRA. If you do, you will miss out on the tax benefits such as deductions for property taxes, depreciation, mortgage interest, and other expenses related to the property.

Lots of strict rules.

Another downside to self-directed IRA real estate investment is that you must use funds from your IRA to make repairs to your property. Furthermore, you can't do them yourself! You have to hire someone (not in your family) to make the repairs, and utilize your IRA to pay them. Property managers must also be hired using your IRA funds.

If you break the rules, you could disqualify your IRA, which would make all the funds taxable.

You can read more about the rules around SDIRAs here.

You can't withdraw funds whenever you want.

Because it's an IRA, you still have to wait until you reach age 59 1/2 to withdraw your earnings, or else you will incur an early withdrawal penalty.

You can't use the property yourself…until you retire.

The big issue with a self-directed real estate investment is that you can't actually use the property yourself until you retire. You can develop the property and use it as a business, but you can't make personal use of it.

A self-directed IRA real estate investment has pros and cons…

With a self-directed IRA, you can move beyond Wall Street and invest in assets that you know and understand. Real estate is just one of those options.

On the other hand, you might want to forgo an SDIRA real estate purchase once you understand at all strict rules, and the tax benefits you could be giving up.

Related Content:

How to Make Your Money Work for You: 7 Modern Methods for Investing in “The Market”

The 5 Critical Components of Real Estate Investing Returns

Renting vs Owning: Why You Need to Own the Real Estate You Live In (of Which You Will Be the World’s Best Renter!)

Big Picture Investing: Why You Need to Get in the Game Now!

Ambergris Caye Real Estate in Belize: How to Invest in Paradise!

Joe DiSanto is the founder of Play Louder! He has built multi-million dollar businesses, produced critically acclaimed documentaries and an Emmy-winning TV show, invested millions in real estate, and semi-retired at age 43. Now, Joe serves as a Fractional CFO for several creative firms and is sharing a lifetime of fiscal know-how via Play Louder, an invaluable resource that helps individuals and business owners increase their net worth and plan better for their future.