Mortgages & Creative Financing

Take Advantage of an Underused Law — and Invest Using Your Self-Directed IRA

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What is a self-directed IRA? “Self-directed” is not a legally defined term, but an industry term for a retirement account that allows the owner to choose the investments. One option these investors can choose is real estate-related investments, along with a virtually unlimited list of other asset types, including alternatives like hedge funds. Since the 1974 ERISA laws came into being, it has been possible for your IRA and other qualified accounts to own real estate, whether land, a rental house, an office building, or apartments.

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How Are They Created?

You can start a self-directed IRA by opening a new IRA or rolling over or transferring funds from previous employer-sponsored plans or custodians:

Things to Know Beforehand

  • Funds that are in an active 401(k) with a current employer typically cannot be utilized unless the plan allows true self-direction.
  • Employees that are 59½ years old or older may be allowed an “in-service” distribution that allows funds in an active plan to be rolled over into an IRA without penalty.
  • All IRAs can be self-directed.

tax-changes

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

Plan Types Eligible for Self-Direction

You can use any type of retirement plan for self-direction:

  • Traditional or Rollover IRA
  • Roth IRA
  • Simplified Employee Plan (SEP)
  • Savings Incentive Match Plan for Employees of Small Employers (SIMPLE)
  • 401(k) Plan

IRS Rules and Investment Options in an IRA

The IRS does not approve or disapprove of all assets that you can invest in — there are no real approved investments as far as the IRS is concerned. They only tell us what is disallowed in an IRA, which is collectibles and life insurance, because a value cannot be established. Remember, the real estate and any income it generates or the cash from flipping properties stays inside the IRA — at least until you turn 59½, when you can legally withdraw it.

Investment Options

  • Real Estate (Commercial, Residential, and Land)
  • Private Lending
  • Private Equity
  • Limited Liability Companies (LLCs), Private Limited Partnerships (LLPs)
  • Precious Metals
  • Brokerage (Stocks, Bonds, ETFs and Mutual Funds)

In almost 95 percent of the existing IRAs in the United States, the brokerage option is exercised the most. Why? Because most brokerage firms do not have departments capable of administering these alternative (and in many cases too complex to administer) options. There are a few highly respected firms that can administer these other investment choices — Millennium Trust being the 800lb. gorilla in the room.

If you look at the IRS guidelines, they say it’s legal to invest in real estate. However, not all trustees or custodians (IRA providers) are required to offer real estate or other alternatives as investment options.

It’s Your IRA, But…

It’s not quite you investing personally with your own name — you’re actually using the IRA in its own identity. It acts as its own closed-loop legal entity separate from your personal finances. When the IRA makes an investment, the money leaves the account, it goes and purchases something, and then any income or profits from a sale comes right back into the IRA.

The other portion you need to understand is that when you have a self-directed IRA anywhere, it’s actually the provider or the IRA administrator that’s signing all the legal documents on behalf of the account because it’s always going to be titled in that name of your provider, not your name. For your benefit, it will include your name, but the name on the title will also be the account administrator.

Related: The Self-Directed IRA: What You Should Know About This Wealth-Building Tool

Benefits of Buying Physical Real Estate in an IRA

  • Income is created right away off of the properties’ cash flow.
  • Real estate can be inspected and is usually easy to value.
  • Real estate can be purchased below market and fixed up, thus adding value.
  • Tax is not paid on income or profits.

Downsides of Holding Physical Real Estate in an IRA

You can’t take any deductions for interest paid, expenses, or loss of any kind because the property is already inside a tax-advantaged account.

Retirement Implications

Historically, investors who understand the risk-return tradeoff of this asset class have built significant net worth. With less than 5 percent of U.S. retirement accounts including real estate of any kind, we feel it is an important piece for our clients to consider in a well-diversified portfolio.

This guide is for informational purposes; neither the information nor any opinion expressed constitutes personal advice. Please consult an expert before changing your personal finances, legal, insurance, or tax plan.

Do you used a self-directed IRA to invest? Why or why not?

Let’s talk in the comments section below.

Stephen Vettorel is the Founder and Portfolio Manager of Benchmark Wealth Advisors, LLC. Stephen began his wealth management career in 1998, developing and implementing long-term investment strateg...
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    Rob Cook from Powell, WY
    Replied almost 4 years ago
    Another rule about owning real estate property in a self directed IRA, is that you cannot do any fixup work on it yourself. Doing so can jeopardize the IRA tax treatment. So, if you are a hands-on owner, this avenue of creating sweat equity is not available in self directed IRA.
    Deanna Opgenort Rental Property Investor from San Diego, CA
    Replied almost 4 years ago
    : ( The only reason I haven’t done this…..
    James Maness Investor from Baton Rouge, LA
    Replied almost 4 years ago
    Can you act as the property manager but not collect any salary?
    Peter Rizzo Financial Services from Minneapolis, Minnesota
    Replied almost 4 years ago
    Yes you can do administrative duties such as collecting rents ,paying bills etc.. Any improvements or maintenance you should hire out.
    John C. Investor from New York, NY
    Replied almost 4 years ago
    Good to know
    Nicolas Blish from Ponchatoula, LA
    Replied almost 4 years ago
    What are some good providers of self directed IRAs that allow you to hold real estate? I have a 401K to rollover and would like to pursue this route.
    Susan Maneck Investor from Jackson, Mississippi
    Replied almost 4 years ago
    Sense Financial does both self-directed IRAs and solo401K. I like them for two reasons. I’ve never heard them suggest you do something illegal like start your own business with them. I keep seeing these ads suggesting you do just that. Second, they are extremely accessible. I’ve sent messages to Dmitriy (the owner) at midnight and gotten answers within the hour. Dmitriy, is a Bigger Pockets member, btw.
    Susan Maneck Investor from Jackson, Mississippi
    Replied almost 4 years ago
    What worked even better for me was a solo401K. Of course you have to have some income on the side, but not much. Just something that generates a 1099. I do a little consulting work and make between 4-20K a year. Usually it is closer to the 4K than the 20K. By itself that doesn’t buy much real estate, but I was able to roll-over my IRAs into it and that was enough.
    Susan Maneck Investor from Jackson, Mississippi
    Replied almost 4 years ago
    I might add, with a solo401K you don’t have to have an LLC like you do a self-directed IRA.
    Abraham Pierce from Powder Springs, Georgia
    Replied almost 4 years ago
    I have a self directed Roth IRA but need advice on finding investments any help appreciated.
    Robert Polyack Investor from Kingsburg, California
    Replied almost 4 years ago
    We’ve worked with both EquityTrust (self-directed real estate iras — Bryan Dobro) and Guidant Financial (C-corp Roll-over Business Start-up coined ROBS ;-)). I highly recommend both as they have been doing it for years, have much experience and are very responsive.
    Allen Gunter from Austin, Texas
    Replied almost 4 years ago
    Just be sure you understand the unrelated business income tax (UBIT) rules, especially if a loan is involved. The inclination is to think that all income and capital gains in a self-directed IRA are tax-deferred (or tax-free in a Roth) because that’s how it works with investments like stocks and bonds. UBIT comes into play with real estate investments, however, particularly if your IRA takes on debt to buy the real estate. It even applies if you passively invest in an LLC, for example, that is the actual owner of the property and the LLC financed the purchase. I was considering using my IRA in an investment that would have involved taking on some debt, but after having done a lot of research and consulting with my CPA, I’ve decided the potential tax issues are too onerous. And if you don’t get it right, you could end up with a prohibited transaction which could disqualify your whole IRA. I’m not saying don’t do it, just that it’s not necessarily the simply slam-dunk it would seem to be. Be sure and do your homework first!!
    James Rodgers Investor from Birmingham, Alabama
    Replied almost 4 years ago
    This is awesome stuff. I wish I could find more articles like this on BP. I have 2 questions: 1. What is the most cost-efficient way to get my funds in my company-setup 401k investing into real estate? They match 4.5% on my first 6% of paycheck. ANY way for me to keep getting their match, but getting it all put into real estate?? That would be AWESOME. 2. I read an article on BP recently about the biggest hidden benefit to REI: the tax benefits. Namely depreciation, interest on mortgage, tenant rent, and something else… It was one of the BP writers. Does all of that (besides tenant income) go out the window when we’re talking about self-directed?
    Stephen Vettorel Investor from Temecula, California
    Replied almost 4 years ago
    Thanks for the comments James. It gets quite tricky if you are still employed and active in your company’s 401k. Depending upon your age and your plan docs, it may be possible to do a in-service withdrawal. Contact you 401k admin and ask that question. http://www.investopedia.com/terms/i/inservicewithdrawal.asp
    Dmitriy Fomichenko Solo 401k Expert from Anaheim Hills, CA
    Replied almost 4 years ago
    James, to answer your questions: 1. If you have a 401k with your current employer you will not be able to self-direct those funds until you either leave the employer or reach retirement age. But until then keep contributing up to the amount they match and if you can contribute more you should direct those funds into an IRA. 2. This is correct, when you invest in real estate in your IRA it does not affect your personal taxes so there is no depreciation deduction. But you still might be ahead if you go this route comparing to the stock market with you can’t control.
    Paul Salmela Investor from Minneapolis, Minnesota
    Replied almost 4 years ago
    Check with your employer to see if you can do an in-service withdraw on your 401k. I work for a large company and was able to transfer 20% of my 401k to a traditional IRA. I then used this (and other retirement funds) to create my self-directed IRA.
    JL Seymore from Waxhaw, North Carolina
    Replied almost 4 years ago
    It’s been my experience that Nevada tends to be one of the more consumer/investor friendly states when it comes to Self-Directed IRA. JLSeymore
    Doug Rich House Flipper / Investor from Gresham, Oregon
    Replied almost 4 years ago
    Soo, with the can’t work on it rule in place, I, like many other fix and flip investors, because we do what we can to the property ie: demo, cleaning, small fixes, etc. to help the bottom line. Many have an IRA that we can not use on our own project, but we can use for another flippers project. Is there a meeting place for all of us so we can use each others IRAs ?
    Dmitriy Fomichenko Solo 401k Expert from Anaheim Hills, CA
    Replied almost 4 years ago
    It is very common for people to use their retirement funds to fund other investor’s deals. Just yesterday I wired funds to fund a short term loan for a flip of local investors. I also have few long term notes as well. There are many opportunities out there.
    Kelly Bredlow Note Investor from Austin, TX
    Replied almost 4 years ago
    Hello BP, I have come across an opportunity to be invest with my Self-directed Roth IRA and it be named as a Venturer in a Joint Venture agreement. The purpose is clearly defined for this flip and all Management decisions are defined as being up to the LLC performing the renovations. I am a little hesitant as to how being listed as a Venturer with the Self-directed Roth IRA appears per the tax rules, especially if the deal goes south. What kind of questions should I be asking? What should I be looking out for? I appreciate your comments.
    Dmitriy Fomichenko Solo 401k Expert from Anaheim Hills, CA
    Replied almost 4 years ago
    Kelly, you can participate in the flip venture but you need to be aware of the tax consequences for your IRA. Flipping will probably be considered an active business which is unrelated business and when tax exempt entity such as an IRA engages in such activity UBIT tax would be assessed on income from such activity. Be sure to consult with an experienced CPA before moving further.
    Laura Sacandy Investor from Mableton, Georgia
    Replied almost 4 years ago
    In what ways can someone invest in real estate using his/her self-directed IRA and avoid the UBIT?
    Dmitriy Fomichenko Solo 401k Expert from Anaheim Hills, CA
    Replied almost 4 years ago
    Laura, the UBIT tax is triggered when your IRA engages in an active business activity, for example: flipping or wholesaling. Also, when your IRA receives Unrelated Debt Finance Income (UDFI), which is triggered when you finance investment property in an IRA, please note that Solo 401k is exempt from being taxed on leveraged RE, you can learn more here: https://www.biggerpockets.com/blogs/2810/21298-solo-401k-advantages So the bottom line when you invest passively using your IRA (buying rental or being a private lender, etc.) you will avoid UBIT.
    TJ McDonald from Iowa City, Iowa
    Replied almost 4 years ago
    This was a great article to find. Thank you to the experts that are responding to the questions in the comments. What I wanted to do seemed simple, but after reading this article/thread I’m not so sure anymore. I have several different types of IRAs and I wanted to use the money in one of them to make a down payment on a property that would be a residential residence. So, this rental property would still be mortgaged by the bank, but the funds for the down payment I make would come from my IRA. I realize there are other things to be aware of but is step 1 of this plan possible?
    Dmitriy Fomichenko Solo 401k Expert from Anaheim Hills, CA
    Replied almost 4 years ago
    TJ, it is possible to setup a self-directed IRA but you can only use that to make investments. The rules prohibit you from receiving any personal benefits from the IRA or any investments it owns. Therefore you ware not allowed to use your IRA to purchase personal residence. You will need to look at other sources of funds to fund the purchase of residence, tax-deferred vehicle will not work in this situation.
    Mark Scott Investor from Fayetteville, North Carolina
    Replied almost 4 years ago
    Can my LLC take out a loan from my IRA, fix and flip a property, then pay the interest on the loan back to my IRA when the property sells? Title on the property would be held under my LLC. Then purchase another property and do the same thing.
    Dmitriy Fomichenko Solo 401k Expert from Anaheim Hills, CA
    Replied almost 4 years ago
    Mark, your LLC is considered to be a “Disqualified Person” to your IRA. IRS rules prohibit your IRA from conducting any business (lending) with any such person or entity. More on Disqualified Person here: https://www.biggerpockets.com/blogs/2810/47960-disqualified-person-in-a-self-directed-ira-or-401k