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Podcast Hard Money Lenders Books Washington
BlogArrowPersonal FinanceArrowHow to Invest in Real Estate With a Self-Directed IRA
Personal Finance Dec 10, 2020

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

Scott Smith
Expertise: Landlording & Rental Properties, Business Management, Personal Finance, Real Estate News & Commentary, Real Estate Investing Basics
102 Articles Written
Family couple consultations with a lawyer or insurance agent.

 

Disclaimer: This is designed to provide general information regarding the subject matter covered. It is not intended to serve as legal, tax, or other financial advice related to individual situations. Consult with your own attorney, CPA, and/or other advisors regarding your specific situation.

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IRAs allow you to make tax-deferred investments while you are working so you’ll reap the rewards when you retire. Typically, someone else (often a custodian like Charles Schwab, eTrade, or TD Ameritrade) manages those investments for you, keeping your money in stocks, bonds, and mutual funds.

But what if you want to use your IRA to invest in real estate?

Rolling over your retirement assets into a self-directed IRA, also known as an SDIRA or solo IRA, gives you flexibility and potential for greater returns. I help clients roll over their existing 401(k)s and IRAs into SDIRAs all the time, and most of them love that the SDIRA lets them invest in:

  • Commercial property
  • Shopping centers
  • Office parks
  • Duplexes
  • Residential homes (sales and flips)
  • Tax deeds
  • Condos/townhomes
  • Real estate notes/mortgage notes
  • Tax liens certificates
  • Purchase options
  • Raw land
  • Apartments
  • Mobile homes and mobile home parks
  • Vacation rentals
  • Joint venture investments

And that’s actually the shortlist. There are many more opportunities available.

Related: Top 5 Hacks To Maximize Retirement Savings

strip mall with clothing storefront in view

Ditch Your Custodian

As I said, the big IRA companies will keep your money in stocks, bonds, and mutual funds. But if you know about negotiating contracts, performing due diligence, and finding deals in up-and-coming markets, you probably know how to beat Wall Street with smart real estate investments. If that's the case, don't you want control over how your IRA is invested?

But watch out: IRA companies sometimes use the term “self-directed” to describe what they offer. But this is wrong. Their robo-advisors aren’t going to give you the control you need to put your money in investments that will outperform the stock market.

Advantages of a Self-Directed IRA LLC or Business Trust

One way to achieve greater discretionary and more immediate control over the funds in your self-directed IRA is to form an IRS-approved legal entity into which the funds of the IRA are invested. You (as the IRA owner and the manager/trustee of that legal entity) will assume direct control over those funds and how they are used.

Business trusts and limited liability companies ("LLCs") are two types of entities typically used for this purpose. With a business trust the IRA owner will serve as the trustee. With an LLC, the IRA owner will serve as the manager. In both cases, the holding entity gives you full "checkbook control," meaning you will no longer be bound by the rules and regulations of a traditional IRA custodian, nor will you have to waste time waiting for a custodian's approval to make an investment transaction.

Related: The 5 Best Investments in My Self-Directed IRA

What Is Checkbook Control?

Checkbook control simply refers to the ability to invest in anything that the IRS allows, including a broad range of nontraditional investments. It’s a highly desirable feature. Rarely is there a literal checkbook involved, but it can be helpful to think of the checkbook as a metaphor for how your plan’s assets are managed.

Essentially, checkbook control is the aspect of your account that allows you to break free from the shackles of custodians and traditional investments. Checkbook control means you can invest, divest, and manage any qualified investments from your retirement funds at any time. You may also be able to prevent unnecessary overheads from fees, taxes, and expenses—all with the asset protection benefits that come from full confidentiality.

Related: Using a Solo 401k To Invest in Real Estate: How Does It Work?

If you want the freedom to control how your retirement assets are invested and the ability to diversify these investments, then you need this feature. The driving factor is to avoid having to submit documentation for each investment transaction or transfer of funds to the IRA custodian for their review and approval. This review process can take up to 2-3 days and moreover, the custodian usually charges a fee for both the approval process and the transfer of funds to the investment. Ouch!

Why waste your retirement funds on such administrative overheads? Why risk missing out on a hot property because another investor got it first (while you were waiting for a bureaucrat to approve the purchase)?

investor-real estate

How to Use a Self-Directed IRA for Real Estate

With a self-directed IRA LLC or business trust, the IRS permits using your retirement funds to make almost any type of investment, including real estate or raw land. Making a real estate investment is as simple as writing a check from your self-directed IRA bank account.

The advantage of purchasing real estate with your self-directed IRA LLC is that all gains are tax-deferred until a distribution is taken (pre-tax 401(k) distributions are not required until you turn 70½). In the case of a Roth self-directed IRA, all gains are tax-free.

For example, if you purchased property for $500,000 and you later sold for $800,000, the $300,000 of gain appreciation would generally be tax-deferred.

If you purchased the property using personal funds (non-IRA funds), the gain would be subject to federal income tax and probably state income tax, as well.

Related: 6 Tax Scams Guaranteed to Set off Alarm Bells With the IRS

But there are a few differences as far as the “backend” is concerned:

  • All expenses paid from the investment property go through your self-directed IRA LLC or business trust.
  • All rental income checks must be deposited directly into your self-directed IRA LLC (or trust) bank account.
  • Title to the investment property and all transaction documents should be in the name of the self-directed IRA LLC (or trust).
  • Documents pertaining to the property investment must be signed by the LLC manager. The manager can be you.

When using a self-directed IRA LLC (or trust) to make a real estate investment, there are a number of ways you can structure the transaction:

  • Use your SDIRA funds to make 100% of the investment
  • Partner with your family, friends, etc.
  • Borrow money for your SDIRA

Partnering with your family and friends to make a real estate purchase won’t trigger a prohibited transaction if your self-directed IRA LLC or business trust is set up correctly. That’s why it’s important that you get professional help when you’re setting everything up.

Also, when it comes to borrowing money, you must use a non-recourse loan. That is, unless you want to trigger a prohibited transaction and pay UBTI (Unrelated Business Taxable Income) tax.

Buy a Retirement Home With Your Self-Directed IRA

With a self-directed IRA, you can buy an investment property and distribute later for personal use. You can even use your account to acquire the perfect home for your retirement years. This makes your retirement home a retirement benefit!

So, how does this work? You’ll need to purchase the property through your IRA, which will own it as an investment until you retire. You can rent the property until you are ready to retire and move in, making money off of it in the meantime. But you and your family cannot use the property—that’s a prohibited transaction.

Remember: You do not own the property; the IRA does. The IRA rents the property to your tenants. You don’t.

cash-on-cash-return-real-estate

The rental income accrues in your account because, once again, your IRA owns the property. You can lease it to someone outside the family until it's been distributed, but after that, your dream home is all yours.

When that time comes, you will distribute the property via title transfer from your self-directed to your traditional IRA. It is an “in-kind” distribution, and it means taxes are due for traditional IRAs. If your future retirement home was appraised at $250,000, you will receive a 1099-R for $250,000 from your custodian upon distribution.

Distribution taxes can be high. You might prefer to take partial distributions over time to spread out the pain.

Invest Overseas With Your Self-Directed IRA

Not only can you use your SDIRA to invest in real estate in the United States, but you can also invest in residential and commercial properties abroad. Here are just a few scenarios where you might want to invest overseas:

  • Do you want to have a vacation home in Costa Rica? Buy a beach house now, rent it out until you turn 59½, then take ownership of the property tax-free when your SDIRA becomes available for distribution.
  • Did you immigrate to the U.S. for work? You can buy a property in your home country now, develop it over the years, rent out the home, and at the age of 59½, return to your homeland.
  • Want a string of rental homes throughout several countries for vacationers to rent throughout the year? With the SDIRA, you can enjoy the profits generated by high-end vacation home rentals in hot spots like Venice, Amsterdam, Cancun, and the Bahamas.

Related: Considering Moving Abroad? Here’s How Taxes Work

Conclusion

Buying real estate with a self-directed IRA is essentially the same as buying real estate personally, except you have more tax-savings potential and more potential to grow your nest egg.

To set one up, get help from someone well-versed in the investment benefits of the self-directed IRA business trust or LLC. They should be intimately familiar with the lengthy list of prohibited transactions, so you can make sure that your account does not engage in them or incur any unnecessary and costly penalties.

Disclaimer: This is designed to provide general information regarding the subject matter covered. It is not intended to serve as legal, tax, or other financial advice related to individual situations. Consult with your own attorney, CPA, and/or other advisors regarding your specific situation.

Questions? Comments? 

Join the discussion below.

By Scott Smith
Scott Royal Smith is an asset protection attorney and long-time real estate investor. His law firm, Royal Legal Solutions, helps thousands of real estate investors and entrepreneurs in all 50 states protect more than $1.2 billion in assets. Since 2014, he has published over 1,000 posts and articles on BiggerPockets and has appeared on hundreds of podcasts.
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17 Replies
    Karen Salem Real Estate Agent from Palm Coast, FL
    Replied 3 months ago
    I want to set one of theses up. Can you recommend who I can use to set one up, get help from someone well-versed in the investment benefits of the self-directed IRA business trust or LLC?
    Stephen Predmore Rental Property Investor from Baltimore, MD
    Replied 3 months ago
    @Karen Salem. I had a good experience with Brian Eastman from Safeguard Advisors in setting up my checkbook control IRA LLC. He's very active here on BP. Just search on checkbook control for lots of forum posts.

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    Dana M. Rental Property Investor
    Replied 3 months ago
    Yes, very interested if you know someone specific to connect with on this. Thanks for your help, great article!

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    John Murray from Portland, Oregon
    Replied 3 months ago
    I'm a multimillionaire, to take a highly liquid investment and convert to RI which is not highly liquid is a bad idea. This includes RI in a self directed IRA or other investment conduit. RI is not highly liquid and should not be invested in an IRA or the like. Your tax benefits of RI are tied up until you realize the funds. Repair, depreciation and RI reinvestment of funds through BRRRR is a complex tax nightmare. Keep RI and IRA separated,
    Jerome Kaidor Investor from Hayward, California
    Replied 3 months ago
    My tax advisor - advised against such. One real pitfall is - what if your investment suddenly needs a new roof? You can't throw your own cash at it willy nilly, because there are yearly limits on what you can "contribute" to your IRA. Also, if you take out a loan to buy your investment there is some sort of tax on that.

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    Steve Vaughan Rental Property Investor from East Wenatchee, WA
    Replied 3 months ago
    Agree, John. Lots of rules and you can't take depreciation. I would consider lending from my IRA, but wouldn't hold.

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    Nick Melillo
    Replied 3 months ago
    Karen, I used Entrust. Very knowledgeable and good customer service. They have a great knowledge video library.

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    Joe Steele Real Estate Agent from Los Angeles, CA
    Replied 3 months ago
    Excellent article Scott, thank you for sharing this useful info.

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    Patrick McCarthy
    Replied 3 months ago
    I have been planning to move funds into a Solo 401k but the biggest challenge is now finding a bank/ender that will provide long term non recourse financing for a buy and hold investment. Hard money lenders are out there but long term financing is much more difficult to find. I was hoping to find a local community bank to build a relationship with but most don't know what non recourse lending is and have no interest once they figure it out. If anyone has any suggestions, it would be much appreciated.
    Amar Kapadia
    Replied 3 months ago
    Hi Patrick, I already moved funds into my Solo 401K and am struggling with this issue. I see two options -- go 1-4 units in which case the interest rates are 5.5%+ with a max LTV of 60% (so the returns are not that awesome) OR go with 5+ units in which case I might be able to get very attractive commercial non-recourse loans. LMK if you have any thoughts/insights.

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    Dmitriy Fomichenko Solo 401k Expert from Anaheim Hills, CA
    Replied about 2 months ago
    Here is a list of lenders offering non-recourse financing to IRAs and Solo 401Ks: https://www.biggerpockets.com/member-blogs/2810/50272-list-of-non-recourse-lenders-for-self-directged-ira-and-401k

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    Hank Lee from Lakewood, Colorado
    Replied 3 months ago
    I've not seen one article on this topic talk about strategies for handling RMDs. It's much more complicated than a portfolio of stocks and bonds. I'd love to hear about strategies and real world examples of how this works.

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    Mark Metry Investor from Central NJ
    Replied 3 months ago
    Great article. One gotcha if going this route that people should be aware of... If using a self-directed IRA to purchase the property and you intend to use a mortgage in the LLC to buy the property (will likely need to be a non-recourse loan), you will need to pay Unrelated Business Income Tax on the income. This tax goes up to 37%, which can definitely hurt your ROI... I believe this tax does not apply if the property is purchased in a solo-401k.

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    Alex Fatal Investor from Miami, FL
    Replied 3 months ago
    I'll probably have to reread the article several times before I fully digest it. Yes, I'm one of those. This question are for those of you that already have a self directed IRA and have actually purchased income producing RE. I take what John Murray from Portland serious in that you don't want all your eggs in one basket. I have a Roth IRA in fixed indexed annuities worth about 22k. But I now have a 17k property that I'm trying to close on that'll pay me 3.5 percent in rent far surpassing what my Roth is giving me. Should I do a SDIRA?
    Dmitriy Fomichenko Solo 401k Expert from Anaheim Hills, CA
    Replied about 2 months ago
    Alex, if the property is in your name - you can't use self-directed IRA to fund it. It is possible to buy investment property inside of your IRA but the entire transaction must be "arms length" (you personally can't be involved in it): the purchase agreement must list IRA as the buyer, the earnest money deposit must come from the IRA and the title must be vested in the name of the IRA.

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    Trina S. Investor from Ramah, New Mexico
    Replied 3 months ago
    I have had good luck with real estate contracts. No repairs, no depreciation, just principal and interest income. I have never had a delinquent payment in over 10 years of various contracts. Just choose your buyers very carefully and make sure they put down at least 20 percent. I tend to do 15 year contracts and I use this income to delay taking social security until I am 70. I have a very good chance of living to be quite old so wish to delay social security as long as possible! I did not do these investments within an IRA as it seemed more complicated at the time and there were not many companies set up to do this, but if I was younger I would do it now. On the other hand taking it as current income may not be such a bad idea depending on your situation, especially as you begin to enter retirement years.

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    Merrill Mixer
    Replied about 2 months ago
    We actually did this after the 2008 downturn, put $50K from our IRAs into a LLC and a SDIRA which we used in December 2011 to purchase a $49K condo in CA for a rental. Without a loan and with low taxes and holding costs It always cash flowed. As the rent proceeds grow inside the checking account we had to look for other ways to invest always keeping some liquidity. We sold the condo in August of this year for $165K. The whole investment netted us over $210K tax sheltered from a $50K investment. We are now shopping for a new opportunity that we hope will give that kind of return again! (We use ForgeTrust as our custodian. Our only complaint are the fees which increase yearly.)

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