Mortgages & Creative Financing

The 5 Best Investments in My Self-Directed IRA

Expertise: Business Management, Mortgages & Creative Financing, Landlording & Rental Properties, Real Estate Investing Basics, Personal Finance, Real Estate Deal Analysis & Advice, Commercial Real Estate, Personal Development, Real Estate News & Commentary
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Hand of Business people calculating interest, taxes and profits to invest in real estate and home buying

Often, newer real estate investors ask me for recommendations on what to invest in. Although I’m honored to be asked, I usually let them know that I’m not a CPA and that the answer to that question depends on many factors, including their investing goals, level of risk tolerance, and amount of capital to invest. (Check out my recent article, “How to Invest Your Money When You’re NOT a High Net Worth Investor.”)

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That said, when it comes to investing capital from my self-directed IRA, I do have my own set of “favorite” investments. So, what are these preferred investments?

The 5 Best Investments in My IRA

1. Business Equity

Owning a business in your IRA is a great way to build your net worth. Although you may need to pay UBIT (unrelated business income tax), it still enables you to get more money into the qualified plan. Remember though that you can’t “self-deal” in your IRA, so the business your IRA owns needs to be separate from you and prohibited family members. Also, your personal involvement in the business needs to be minimal. So a great business to own in your IRA might be an out-of-state franchise—or in the real estate world, a business like a title company that you don’t personally use in your transactions.

Related: How to Invest in Real Estate With a Self-Directed IRA

2. Performing Notes/Private & Hard Money

This is one of my favorite investments, but even more so when I own it in my self-directed IRA. Investing in performing notes is extremely passive, especially if you hire a mortgage servicer, who will do all the accounting and management for you.

Another great option is to lend out of your IRA. To stay in the real estate realm, your IRA can step into the hard money role and fund rehabbers on acquisitions and repair costs. Thinking beyond real estate, I guarantee there are local business owners with solid operations who can use more capital for equipment, inventory, or even operating expenses, who would be interested in doing a loan with your IRA. The key, of course, is to make sure your IRA is covered in the event of default.

3. Shares of an LLC

There are many opportunities to passively invest in fund offerings or purchase shares of LLCs. This is true mailbox money, as you are not actively involved in a business’s day-to-day operations (i.e., you have no liability), and yet you still benefit from the business’s success. Think of it this way: Instead of owning an entire business (like in #1 above), your IRA becomes a fractional owner of a business or entity. If you go this route, all the rights and responsibilities of ownership should be spelled out in the operating agreement, so have your attorney review it. The point here is to buy an interest in a business that spins off cash and/or is likely to increase in value so that your IRA stands to benefit from the upside when the shares are sold.

4. Options

Options, particularly lease options, appeal to me most because they require very little capital, yet the earnings can still build tax-free within my Roth IRA. I could write a book on options, but the main point is that your IRA can buy the right (aka the “option”) to do certain things like purchase real estate for what is usually a pretty small amount of money. That option may gain in value when another buyer steps in and wants the property. It’s almost like a lien that has to be paid off for a buyer to acquire a property.

Search “options” on BiggerPockets to get the whole story. This strategy is worth knowing about.

5. Wholesale & Flip Real Estate

By purchasing wholesale and selling to a retail buyer or even another investor, you can still make a nice spread, while maintaining a more passive role in the deal. It’s much more favorable to do inside your IRA because it’s so highly taxed as a short-term capital gain outside a qualified account. The key here is structuring the deal so that the IRA’s ownership is truly independent of your personal actions. Maybe a “financial friend” could sell your IRA a fixer-upper house for $50K and then the IRA would turn right around and re-sell the house to a rehabber for $60K. Think about ways your IRA can get into deals like this, and you’ll soon realize that the possibilities are unlimited.

Related: 3 Pros (& 2 Cons) of Self-Directed IRA Investing

So, Why These Investments Instead of Others?

The investments I mentioned above usually come with less management headaches and aggravation than investments like buy and hold real estate, for example, which often require more work to own inside one’s IRA. As an example, with buy-and-hold property, do you realize that in most cases (checkbook IRAs aside), you have to have your IRA custodian issue checks to pay contractors for repairs, pay municipalities for taxes due, and so on? And if you have any experience with typical custodians, you know that these seemingly simple requests often involve lots of paperwork and lots of time monitoring the custodian.

Active and Tax-Advantaged Investments

Is it better, sometimes, to use regular cash to fund your investments? Yes! Some tax-favored investments, like apartments or funds that purchase apartments, may be better utilized owning outside of my IRA so I can still benefit from all the tax advantages like depreciation, repair expenses, and mortgage interest deductions, etc.

I also prefer not to own super active investments in my IRA (i.e., buy and hold real estate deals, non-performing notes, etc.), as I don’t want to run the risk of disqualifying my retirement account. Be sure to check your custodian’s list of prohibited transactions to get clear on what’s allowed and what isn’t. Typically, actively managed investments are more frowned upon because they’re the most dangerous with the risk of disqualification.

WARNING: If a prohibited transaction occurs, the IRS could disqualify your IRA, essentially changing its tax-exempt status and making it a nonexempt trust. You would then be taxed on the entirety of your account. For example, even if you only invested $10,000 into the deal, but your account was worth $1MM, your whole account would be taxed. Ouch.

So, again, think of ways to establish that arm’s-length relationship with your IRA. For example, a safer way to invest in non-performing notes from an IRA may be to hire a specialty servicer who does all the borrower management on the IRA’s behalf. Likewise, you could hire a general contractor for the rehab on your fix-and-flip deal or a property manager for a buy and hold property owned by your IRA.

I’ve mentioned some of my favorite investments to own in my self-directed accounts, so what are some of yours? Or what do you purposefully invest in outside of your IRA?

Comment below!

Since 2007, Dave Van Horn has served as president and CEO of PPR The Note Co., a holding company that manages several funds that buy, sell, and hold residential mortgages nationwide. Dave’s expertise is derived from over 30 years of residential and commercial real estate experience as a licensed Realtor, a real estate investor, and a fundraiser. As the latter, Dave has raised over $100 million in both notes and commercial real estate. In addition to his investments and role as CEO, Dave’s biggest passion is to teach others how to share, build, and preserve wealth. He authored Real Estate Note Investing, an introduction to the note investing business, helping investors enter the “other side” of the real estate business.

    William Randolph Investor from Hampton, VA
    Replied almost 2 years ago
    Good post. Thanks. Just learned about your company and have been thinking about adding notes fund investing to my SDIRA. WHAT TIMING!
    Dave Van Horn Fund Manager from Berwyn, PA
    Replied almost 2 years ago
    Thanks William! Feel free to reach out and PM if you have any questions or if there’s anything I can help you with. Best, Dave
    Tatsiana Ela Real Estate Investor from San Jose, CA
    Replied almost 2 years ago
    Very useful information and examples. Thank you
    Matt Franklin Rental Property Investor from Portland, OR
    Replied almost 2 years ago
    Thanks for this. I just opened my checkbook IRA and have been looking for investment opportunities. I must admit, though, you’ve got me a bit nervous about IRS disqualification now…
    Dave Van Horn Fund Manager from Berwyn, PA
    Replied almost 2 years ago
    It’s just something to keep in mind! Thanks for reading. Best, Dave
    Carol Bloom from Scottsdale, Arizona
    Replied almost 2 years ago
    I don’t think you can do flips with a self-directed 401K without getting taxed. I’d talk to your CPA/attorney first.
    Pavel Sakurets Investor from Minneapolis, Minnesota
    Replied over 1 year ago
    You can’t, because it will be considered as ”active” involvement. Even though one can argue that he/she used a construction manager to asses the work, coordinate subs, purchasing materials, supervising work, etc. I don’t know IRS statistics if any cases like this held up.
    Bob Malecki Lender from Kingston, WA
    Replied over 1 year ago
    I have 3 family member’s Roth IRAs partnered in a LLC, we liquidated our rental properties about 4 years ago and used the capital to buy residential notes and never looked back. Now investing in some select cryptocurrencies as well.
    Bob Malecki Lender from Kingston, WA
    Replied over 1 year ago
    I have 3 family member’s Roth IRAs partnered in a LLC, we liquidated our rental properties about 4 years ago and used the capital to buy residential notes and never looked back. Now investing in some select cryptocurrencies as well.
    Jason Barnett Flipper/Rehabber from Memphis TN
    Replied over 1 year ago
    Thanks again for the great ideas! Jason
    Jason Barnett Flipper/Rehabber from Memphis TN
    Replied over 1 year ago
    Thanks again for the great ideas! Jason
    Bryan Drury Investor from Owensboro, Kentucky
    Replied over 1 year ago
    Dave, Appreciate your posts. I find them very informative and thought provoking. I to prefer plenty of arms length from prohibited transactions due to the risk. Private money lending has worked out well, and very passive. Thanks for your time and perspective!!
    Katharine Bailey
    Replied 11 months ago
    Appreciate all these posts. But, I’m still confused on the need for an LLC. I am planning to rollover my IRA into a SDIRA. The intention being to offer real estate lending ( short term mortgages) within the SDIRA to consumers. Do I, or don’t I need an LLC? I’m in Texas. Does the state where the property is located matter? Does the IRS have a rule related to this practice? For the record, I demand the property be heavily insured.
    Gopinath Chandra from Union City, California
    Replied 19 days ago
    I just opened a SD IRA. Applied to transfer a portion of my old 401K to this IRA. I am planning to use the SD IRA to invest in crowd funding deals in companies like CrowdStreet. Any pitfalls do I need to watch for?