Using a Self Directed IRA to Invest in Real Estate

Dated: December 2 2023

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

Stocks, bonds and mutual funds are the usual way most people invest their IRAs, but there are alternatives. For investors who would rather walk their own path, a self-directed route is one way to go.

Courtesy of Kiplinger

By: Karlin Conklin

A self-directed IRA is a type of retirement account legally structured like a traditional or Roth IRA. Though the same annual contribution limits and potential tax advantages apply, self-directed IRAs allow individuals to utilize what is referred to as non-traditional or alternative investments, such as debt instruments, gold and other precious metals, businesses and real estate.


Banks, brokerage firms and insurance companies have historically controlled the type of investments made with IRAs and 401(k)s. They offer a more traditional approach to investing by limiting options to publicly traded stocks, bonds and mutual funds. Today, with information so readily available from a wealth of sources, investors can research and make sound investment decisions without relying exclusively on these traditional advisers.


People choosing the self-directed route are typically looking for diversification in their retirement investments.


Why Focus on Real Estate?

Real estate is REAL. It is tangible, finite and has historically been a multigenerational builder of wealth. Rather than an alternative retirement investment, real estate can be a key vehicle for growing one’s IRA account.


Why Would Someone Go the Self-Directed Route?


Ask yourself, “Do I want my entire retirement future to be left in the hands of Wall Street and money managers? Or do I feel confident that I can direct some of my funds and actually know where my money is invested?” Some investors believe that giving money managers or Wall Street complete control of their retirement is not the best path for them.


By researching real estate investments and sponsors, you can gain the confidence to make your own choices. You may also find that real estate provides diversification and the potential for better returns, more quickly, than traditional investments.


How It Works


There are two ways to go the self-directed route. You can place the money through a custodian that specializes in self-directed IRAs or open and place the funds via a checkbook IRA account. In either situation, given the investment is self-directed, you must do your homework in order to understand the investment’s opportunity and risks. If there is any debt involved, it must be non-recourse. Maintaining records is critical.

Many of the traditional brokerages that hold IRAs and 401(k) accounts will not move the funds to non-traditional investments; therefore, you will need to direct the funds from your current account to an IRA custodian who works with self-directed accounts. Custodians such as Provident and IRA Services Trust Company have successfully worked with individuals to direct their IRA investments. The key here is to follow the rules and work with a reputable custodian.


What Are the Rules for Investing Directly in Real Estate?


The first rule is to actually follow the rules. If you purchase real estate with an IRA improperly, you can disqualify the IRA, making all the funds taxable. The rules include: no self-dealing (selling or buying to or from a related party), no hands-on improvements via “sweat equity,” and no personal benefits such as living in the property yourself or renting to a family member.

For example, let’s say you invest $100,000 from your IRA, buy a rental property, and let your son and his family move in. Whether or not he pays rent, the investment would be considered disapproved, and if discovered by the IRS the investment could be deemed a full distribution with subsequent taxable penalties.

The real estate must be for investment purposes only, and normally both the invested money and dividends will flow through, and to, a custodian. When the property sells, the proceeds will also go directly back to the custodian or to the IRA checkbook account and can be reinvested once another opportunity presents itself.


What’s an Argument Against Using an IRA to Invest in Real Estate?


The primary argument against using an IRA in this way is that it cannot take advantage of the significant tax shelters provided by real estate, including depreciation and interest write-offs. Stocks and bonds, the normal vehicles driving IRA investments, do not have these special tax incentives either. So, for many people, the investments could be considered on par.

Real estate is considered an illiquid asset; therefore, investors older than 70½ must be aware of Required Minimum Distributions (RMDs) and how their real estate fits with the required withdrawals. See the IRS websitefor more details.


Getting Started


The first step is to do your research. With real estate, you must research the market, including demographics, income and job growth. Research the investment sponsor who will be managing the real estate on your behalf. The next step is to research custodians. If you go the self-directed route, you will still work with a custodian who places your funds for you. Any dividends or distributions must flow directly back to the custodian.

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