How to Use an IRA for Real Estate Investment

Investing for retirement involves traditional assets. Self-Directed Individual Retirement Accounts (SDIRAs) offer expanded choices, allowing investors to hold alternative assets like real estate. This leverages IRA tax advantages while diversifying with tangible property.

Understanding Self-Directed IRAs for Real Estate

A Self-Directed IRA differs from a traditional IRA by empowering the account holder to make all investment decisions. Unlike conventional IRAs, an SDIRA permits a broader range of assets, including real estate. Investors choose and manage investments, while a specialized custodian holds assets and handles administrative and IRS reporting duties.

Several types of IRAs can be self-directed to invest in real estate, each retaining its inherent tax characteristics. A Traditional IRA, when self-directed, allows for tax-deferred growth, meaning contributions may be tax-deductible in the year they are made, and earnings grow without immediate taxation until withdrawal in retirement. Similarly, a Self-Directed Roth IRA grows tax-free, and qualified withdrawals in retirement are also tax-free, as contributions are made with after-tax dollars.

Simplified Employee Pension (SEP) IRAs and Savings Incentive Match Plan for Employees (SIMPLE) IRAs, typically used by self-employed individuals and small businesses, can also be structured as SDIRAs. SEP IRAs allow for higher contribution limits, and SIMPLE IRAs are designed for small employers to provide retirement benefits. Regardless of the IRA type, the investor directs the investment, and the account’s tax status dictates how contributions, earnings, and distributions are treated.

The custodian’s role is primarily administrative, ensuring compliance with IRS regulations, processing transactions, and maintaining proper records for the SDIRA. They do not provide investment advice or evaluate the legitimacy of an investment. Full responsibility for investment selection and due diligence rests with the SDIRA account holder.

Types of Real Estate Investments Allowed in an IRA

An SDIRA can hold various types of real estate investments. Permissible assets include residential properties, such as single-family homes, duplexes, and multi-family units, which can generate rental income. Commercial properties, including office buildings, retail spaces, and warehouses, are also eligible investments within an SDIRA.

Investors may also acquire raw land, which typically does not generate current income but offers potential for appreciation. Real estate notes, such as mortgages or deeds of trust, where the IRA acts as the lender and receives interest payments, are another allowed investment. Private real estate funds or partnerships can also be held, offering indirect exposure to a portfolio of properties or real estate ventures.

While the range of allowed real estate investments is broad, certain property types and related assets are prohibited. Personal use properties, such as a primary residence or vacation home, or any property for use by the IRA holder or disqualified persons, are forbidden. Collectibles like artwork, antiques, and certain metals, as well as life insurance contracts, cannot be held within an IRA. These prohibitions prevent self-dealing or immediate personal benefit, ensuring the IRA remains solely an investment vehicle for retirement savings.

Steps to Acquire Real Estate within an IRA

Acquiring real estate through an SDIRA involves specific steps for IRS compliance. The first step is selecting a specialized Self-Directed IRA custodian. Unlike traditional brokerages, these custodians handle alternative assets like real estate, providing administrative support and reporting. When choosing a custodian, evaluate their fee structure, experience with real estate transactions, customer service, and online reporting features.

After selecting a custodian, the next step involves opening and funding the SDIRA account. This requires completing paperwork from the custodian. Funding can occur through direct contributions, subject to annual IRS limits, or through rollovers and transfers from existing retirement accounts, such as traditional IRAs, Roth IRAs, 401(k)s, or other qualified plans. Rollovers are common, allowing individuals to move funds from a previous employer’s plan or another IRA into their new SDIRA.

Once the SDIRA is funded, the investor can identify a suitable property and conduct thorough due diligence. This includes performing inspections, obtaining appraisals, and conducting title searches, all of which are the investor’s responsibility. The SDIRA, as the legal entity, will be the buyer of the property, not the individual investor. All contracts and agreements must clearly reflect the SDIRA as the purchasing entity.

When making an offer and proceeding to closing, the custodian, not the individual IRA holder, must sign all transaction documents as the legal owner of the property. Funds for the purchase, including earnest money, closing costs, and the purchase price, must be disbursed directly from the SDIRA account. Personal funds cannot be used for any property-related expenses, as this constitutes a prohibited transaction.

Non-recourse loans can be used to leverage real estate investments. An SDIRA cannot personally guarantee a loan; thus, the loan must be non-recourse, meaning the lender’s only recourse in default is the property itself, not the IRA holder’s assets. These loans typically require a substantial down payment and may have higher interest rates due to increased lender risk. If a non-recourse loan is used, a portion of the income generated by the property may be subject to Unrelated Debt-Financed Income Tax (UDFIT).

Ongoing Management and Compliance

After acquiring real estate within an SDIRA, diligent management and strict compliance are necessary. All property income and sale proceeds must be deposited directly into the SDIRA. All property expenses, including taxes, insurance, maintenance, repairs, and utilities, must be paid directly from the SDIRA. Avoid commingling personal funds with SDIRA funds, as this can trigger penalties.

While the investor makes investment decisions, they cannot personally perform services or “sweat equity” on the property. All maintenance, repairs, and improvements must be carried out by a third-party contractor paid directly from the SDIRA. If a property manager is hired, they must be an unrelated third party, with fees paid from the SDIRA. Meticulous records of all income and expenses are necessary for custodian reporting.

Understanding and avoiding prohibited transactions, as defined by Internal Revenue Code Section 4975, is important for SDIRA real estate ownership. These rules prevent self-dealing and ensure IRA assets are used solely for retirement benefit. A “disqualified person” includes the IRA holder, their spouse, lineal ascendants, lineal descendants, and any entities controlled by these individuals.

Prohibited transactions with disqualified persons include buying property from or selling property to them, lending money to them, or furnishing goods, services, or facilities to them. Using the IRA’s assets for the personal benefit of a disqualified person, such as living in a property owned by the SDIRA, is forbidden. A violation of these rules can result in the disqualification of the entire IRA, leading to immediate taxation of its full value and penalties.

Finally, distributions from an SDIRA holding real estate follow the same rules as traditional IRAs. For a Traditional SDIRA, withdrawals are taxed as ordinary income in retirement, and Required Minimum Distributions (RMDs) begin at age 73. For a Roth SDIRA, qualified distributions, including those from the sale of real estate, are tax-free, provided certain conditions are met. If an in-kind distribution of the property is taken, its fair market value at the time of distribution is reported to the IRS.