How to Buy Real Estate With a Self-Directed IRA

Investing in real estate through an Individual Retirement Account (IRA) offers a unique way to diversify a retirement portfolio beyond traditional stocks and bonds. While most standard IRAs limit investments to publicly traded securities, specialized accounts allow for direct real estate holdings. This approach can provide tax advantages and portfolio diversification. Acquiring real estate within an IRA requires understanding specific rules and engaging with particular financial entities. This guide explores the mechanics, requirements, and considerations for leveraging an IRA for real estate investments.

Understanding Self-Directed IRAs

A Self-Directed IRA (SDIRA) differs from conventional IRAs by offering broader investment options, including alternative assets like real estate. Unlike traditional or Roth IRAs, which typically restrict investments to publicly traded securities, an SDIRA allows the account holder to choose from a wider array of assets. This expanded investment universe requires a specialized custodian to hold assets, process transactions, and ensure compliance with Internal Revenue Service (IRS) regulations.

The SDIRA custodian acts as a passive administrator, executing investment directions from the IRA owner. They do not provide investment advice or conduct due diligence on chosen assets. Their responsibilities include maintaining IRA agreements, processing contributions, transfers, and rollovers, and fulfilling IRS reporting requirements. Custodians are legally prohibited from offering investment recommendations, placing the onus of investment selection and performance entirely on the IRA owner.

Various SDIRA types accommodate different financial goals and tax treatments. These include the Self-Directed Traditional IRA, where contributions are often tax-deductible and earnings grow tax-deferred until withdrawal. A Self-Directed Roth IRA is funded with after-tax dollars, allowing qualified distributions in retirement to be entirely tax-free. Other options include Self-Directed SEP IRAs and Self-Directed SIMPLE IRAs, often used by self-employed individuals and small businesses, all of which can hold real estate assets.

Many SDIRA investors use a “checkbook control” arrangement, often through an IRA-owned Limited Liability Company (LLC). In this structure, the IRA owns 100% of the LLC, and the IRA owner manages it. This enables them to make investment decisions and execute transactions by writing a check from the LLC’s bank account. This provides greater control and can expedite transactions compared to needing custodian approval for every step.

Permitted and Prohibited Real Estate Investments

A Self-Directed IRA offers flexibility for real estate investments, but strict IRS rules dictate what is permissible to maintain its tax-advantaged status. An SDIRA can invest in a wide range of real estate assets. These include residential properties, commercial properties, raw land, mortgage notes, or tax liens.

The IRS imposes “prohibited transaction” rules under Internal Revenue Code Section 4975 to prevent self-dealing and conflicts of interest. A prohibited transaction occurs when the IRA engages in certain dealings with a “disqualified person.” Disqualified persons include the IRA owner, their spouse, lineal ascendants (parents, grandparents), lineal descendants (children, grandchildren), and their spouses. Any entity where the IRA owner or other disqualified persons hold a 50% or greater interest is also considered disqualified.

Examples of prohibited transactions are strictly enforced. The IRA cannot purchase property from, sell property to, or lease property to a disqualified person. Personal use of the IRA-owned property by the IRA holder or any disqualified person is forbidden. This means the property cannot serve as a primary residence, vacation home, or be used by a disqualified family member. The IRA owner also cannot perform “sweat equity” or provide services to improve the IRA-owned property; all work must be paid for by the IRA.

All transactions must solely benefit the IRA, ensuring no personal benefit accrues to the IRA owner or disqualified persons outside of the retirement account’s growth. For instance, borrowing money from the IRA or using it as security for a personal loan are prohibited. If a prohibited transaction occurs, the IRA can lose its tax-advantaged status. The entire account balance may then be treated as a taxable distribution, potentially incurring penalties and taxes.

The Real Estate Purchase Process

Acquiring real estate with a Self-Directed IRA involves a structured multi-step process, beginning with establishing and funding the SDIRA. First, open an SDIRA account with a specialized custodian that facilitates alternative investments. This requires completing an application and providing necessary documentation.

Next, fund the SDIRA. Funds can be transferred from an existing IRA of the same type, or a tax-free rollover can be initiated from an employer-sponsored retirement plan. Annual contributions can also be made, adhering to IRS limits. All funds for the real estate purchase must originate directly from the SDIRA.

With the SDIRA funded, the purchase process begins. The IRA owner identifies a suitable investment property and performs due diligence. Once selected, the offer to purchase must be made in the name of the SDIRA, not the individual. For example, the buyer would be listed as “Custodian Name FBO [Your Name] IRA.”

The SDIRA custodian facilitates the acquisition. The IRA owner provides investment direction, often through an investment authorization form. The custodian then signs all necessary purchase documents, including the purchase agreement and deed, on behalf of the IRA. They also handle wiring funds for the purchase price and closing costs directly from the SDIRA account. This ensures all transaction funds flow through the IRA, preventing commingling with personal funds.

Managing IRA-Owned Real Estate

Once real estate is acquired by a Self-Directed IRA, ongoing management requires strict adherence to IRS rules to maintain its tax-advantaged status. All property expenses must be paid directly from the SDIRA, not from the IRA owner’s personal funds. These include property taxes, insurance premiums, maintenance costs, repairs, utilities, and homeowner association (HOA) dues. The IRA owner submits invoices to the SDIRA custodian, who processes payments from the IRA’s cash balance. If the SDIRA has insufficient cash, funds may need to be transferred from another IRA, new contributions made, or other IRA assets liquidated.

Any income generated by the IRA-owned property, such as rental income, must flow directly back into the SDIRA. This income cannot be received personally by the IRA owner or any disqualified person. Property management companies can be hired to handle rent collection and upkeep, but they must deposit all rental proceeds directly into the IRA account. This strict separation ensures the investment remains solely for the retirement account’s benefit.

When selling IRA-owned real estate, the SDIRA custodian executes the sale documents on behalf of the IRA. All proceeds from the sale must be returned directly to the SDIRA. These funds remain within the tax-advantaged retirement account, available for future investments or distributions.

Be aware of Unrelated Business Taxable Income (UBTI) rules, especially if the IRA-owned property is debt-financed or involves active trade or business activities. For instance, if the SDIRA uses a non-recourse loan, a portion of the income may be subject to Unrelated Debt-Financed Income (UDFI) tax, a component of UBTI. Understanding potential UBTI implications is important for long-term planning, as it can reduce net returns within the IRA.

Distributions and Tax Implications

Understanding distribution rules and tax implications is essential for real estate investments held within a Self-Directed IRA. Distributions from a Traditional SDIRA are generally taxable as ordinary income when received. This is because contributions to a Traditional IRA are often tax-deductible, and earnings grow tax-deferred.

Required Minimum Distributions (RMDs) typically begin at age 73 for Traditional IRA holders (as of 2025). Calculating RMDs for real estate within an SDIRA can be complex because the asset’s value fluctuates. The fair market value of the real estate must be determined annually to calculate the RMD amount, often requiring an appraisal or valuation by a qualified independent third party.

For a Self-Directed Roth IRA, qualified distributions are entirely tax-free and penalty-free. To be qualified, the Roth IRA must have been open for at least five years. The account holder must generally be age 59½ or older, disabled, or using funds for a qualified first-time home purchase (up to $10,000 lifetime limit). Since Roth contributions are made with after-tax dollars, growth and withdrawals are tax-exempt.

Early withdrawals from any IRA before age 59½ are generally subject to a 10% additional tax, plus ordinary income tax for Traditional IRAs. Exceptions to this penalty include distributions for qualified higher education expenses, significant unreimbursed medical expenses, or a first-time home purchase (up to $10,000). These exceptions apply to the penalty, not necessarily to the income tax liability on Traditional IRA distributions. Consult a tax professional to navigate these rules and avoid unintended tax consequences.