How to Invest in Real Estate With a Self-Directed IRA
You know that investing in real estate is an excellent way to:
Generate higher returns than what you get investing in Wall Street
Increase your monthly cash flow
Invest in assets that historically appreciate
Have more control over your investments
Diversify your portfolio
Hedge against inflation
Build wealth and equity
But did you know that you can invest in real estate with a self-directed IRA (SD-IRA) and still benefit from the tax advantages of a traditional or Roth retirement account?
Perhaps you’ve been investing in real estate with after-tax dollars. Or maybe you’re interested in real estate investing, but haven’t come up with the cash to get started yet.
Suppose you already have a significant amount of savings in an IRA, 401(k), or other retirement plan. In that case, you can roll that money over into an SD-IRA and start investing your retirement savings into real estate right away. You just need to know how it works.
How a Self-Directed IRA Works
An SD-IRA is truly self-directed, which means that you make all the decisions regarding the investments held in the account. This is different from a regular IRA, which is maintained and directed by a brokerage, bank, or investment company.
Because brokerages, banks, and investment companies are responsible for thousands or millions of IRA accounts, they typically limit the investments in these accounts to stocks, bonds, ETFs, mutual funds, and money market investments.
A self-directed IRA allows you to choose from many nontraditional asset classes, including real estate, cryptocurrency, precious metals, private equity, and more. The freedom of an SD-IRA allows investors to invest in assets they know while enjoying the tax advantages of a traditional retirement savings account.
Even though your SD-IRA isn’t managed by a brokerage or bank, it must still be held by a custodian or trustee company, which is an entity that specializes in managing transactions, paperwork, and reporting for SD-IRAs. SD-IRAs are heavily regulated by the IRS and come with a complicated set of rules, so the custodian ensures you remain compliant as you invest.
Custodians of SD-IRAs do not provide investment recommendations or advice. They handle the administrative needs of your SD-IRA, but it’s up to you to research and vet your investment opportunities.
Types of Real Estate You Can Purchase With an SD-IRA
There are very few limits on the types of real estate you can purchase through an SD-IRA. (There are limits on what the property can be used for, but more on that below.) You can typically purchase any type of property you like with an SD-IRA, including but not limited to:
Single-family residential homes
Multiplex properties
Apartment complexes
Commercial properties, including storefronts, office buildings, and shopping centers
Vacant land
Storage unit facilities
And more
The investment options are limitless. If you know a lot about a particular type of real estate property that isn’t included on the list above, you can likely invest in that type of property with an SD-IRA.
Rules Associated With SD-IRAs
As stated above, there are many complex rules for investing in real estate with an SD-IRA. However, this isn’t a reason not to do it. A good SD-IRA custodian is well-versed in the rules and will ensure you’re not violating those regulations when you make your investments. We’ve listed a few common rules regarding real estate investments below.
SD-IRA Rule 1: The Property Must Be Purely an Investment
When you purchase a property with funds from an SD-IRA, the property must be purely an investment. The property may not be used as a vacation home, a second home, or office space. Additionally, certain family members, such as children and grandchildren, may not live in the home, even if they pay rent.
What’s more, you or certain family members cannot work on the home, even if you pay family members who are qualified to do so. Ultimately, you and your family members may not benefit in any way from the property. For example, you would not be allowed to pay your son to install flooring or repaint the house, as this would be considered a prohibited transaction.
SD-IRA Rule 2: Disqualified Persons
Many prohibited transactions are prohibited because of the people involved in them. An SD-IRA investment cannot benefit you in any way, so the IRS has constituted a list of disqualified persons that may also not benefit from an SD-IRA investment. In addition to yourself, this list includes:
Any beneficiaries of the SD-IRA
Your spouse
Your parents, grandparents, and great-grandparents
Your children, grandchildren, great-grandchildren, and their spouses
Your SD-IRA custodian and other professional fiduciaries you work with
If you have questions about who or what else (such as a business entity you’re associated with) might be designated as a disqualified person, reach out to the team at Chicago Trust Administration Services today. We’re happy to answer your questions.
SD-IRA Rule 3: Disqualified Property
Above, we stated that there are typically no limits on the types of real estate property you may invest in with an SD-IRA. However, there are limits on property you already own or property that a disqualified person already owns. You may not use property you already own as an SD-IRA investment. Your SD-IRA may only purchase property owned by a non-disqualified person or entity.
SD-IRA Rule 4: The IRA Is the Property Owner, Not You
When you purchase a property with your SD-IRA, the IRA will be listed as the property owner on the title. The title to the property will read “XYZ Trust Company Custodian [for benefit of] (FBO) [Your Name] IRA.” The title will not include your name alone (unless you’ve partnered with the IRA, using your personal funds, to purchase the property jointly).
Because the SD-IRA is the owner (or partial owner, in some cases), property taxes, maintenance costs, and other expenses associated with owning real estate must be paid out of the IRA. This is an advantage for most investors, as you don’t have to maintain the property with your personal funds. However, this can also be a drawback if you don’t have enough money in the IRA to cover these costs.
How to Invest in Real Estate With an SD-IRA
If you don’t yet have an SD-IRA, it’s important to find a custodian you trust to help you set up the account. Then when you find a property you’d like to invest in, and you have the funds ready in your SD-IRA, all you have to do is request that your custodian purchase the property on behalf of your IRA.
It is difficult to get a mortgage loan through an SD-IRA, as the lender only has the option of using a non-recourse loan, which means that you are not personally liable if you default on the loan. Instead, the lender would only be able to pursue recourse by seizing the property and any other funds in the IRA. Therefore, most SD-IRA investors purchase properties outright.
If you don’t have enough cash in your SD-IRA and obtaining a non-recourse loan is not possible or optimal, you can partner with other investors to purchase a new property with your SD-IRA. In this case, your IRA would own a percentage of the property.
Because the funds in an SD-IRA are tax-deductible or tax-exempt, all income from the investment property must be returned to the IRA. However, this allows you the opportunity to invest in more real estate or other assets with your SD-IRA funds as your balance grows.
Contact Chicago Trust Administration Services to Learn More
Investing in real estate with an SD-IRA may sound complex, but it doesn’t have to be. With the right custodian, you have the freedom to invest in asset classes outside of Wall Street – assets that may indeed provide greater returns and options for monthly cash flow in retirement.
To learn more about your options with an SD-IRA or to get help setting up your account, schedule a complimentary 20-minute meeting by calling 312-869-9394 or emailing steve@ctasira.com.