How to Use an IRA to Invest in Real Estate

Using an Individual Retirement Account (IRA) to invest in real estate offers an alternative investment strategy. While most IRAs focus on publicly traded securities, a specialized account allows for a broader spectrum of investments, including tangible assets like real estate. This strategy can diversify a retirement portfolio and potentially generate tax-advantaged returns.

Understanding Self-Directed IRAs

A Self-Directed IRA (SDIRA) is a type of IRA that permits the account holder to invest in a wider array of assets than typically found in conventional IRAs, such as stocks, bonds, and mutual funds. The distinguishing feature of an SDIRA is its allowance for alternative investments, with real estate being one of the most popular choices. The term “self-directed” means the account holder makes all the investment decisions, giving them direct control over their retirement savings strategy.

A specialized custodian, often a trust company or financial institution approved by the IRS, is required to hold the assets within an SDIRA. This custodian’s role involves ensuring compliance with IRS rules, processing transactions, and maintaining records, but they do not provide investment advice or conduct due diligence on the investments themselves. Common types of IRAs that can be self-directed include Traditional IRAs, Roth IRAs, Simplified Employee Pension (SEP) IRAs, and Savings Incentive Match Plan for Employees (SIMPLE) IRAs.

Rules for Real Estate Investments

Investing in real estate through an SDIRA is governed by strict IRS regulations designed to prevent self-dealing and ensure the investments are solely for the benefit of the retirement account. The IRS permits various types of real property to be held, including residential properties, commercial buildings, raw land, and even mortgage notes. However, certain assets like collectibles and life insurance are specifically prohibited.

A core principle is the prohibition against “disqualified persons” engaging in transactions with the SDIRA or personally benefiting from its assets. Disqualified persons include the IRA owner, their spouse, ancestors, lineal descendants (children, grandchildren), and any entities they control. For instance, the IRA owner cannot live in a property owned by their SDIRA, use it for personal vacations, or conduct business from it. Similarly, the SDIRA cannot purchase property from, sell property to, or lend money to a disqualified person.

All income generated by the real estate, such as rental payments, must flow directly back into the SDIRA, not to the individual. Conversely, all expenses related to the property, including property taxes, insurance premiums, and maintenance costs, must be paid directly from the SDIRA’s funds. The IRA owner cannot personally pay for these expenses or perform services like repairs or renovations on the property, as this would constitute a prohibited transaction. Violating these rules can lead to severe penalties, potentially resulting in the disqualification of the entire IRA and making the full account balance immediately taxable, along with a 10% penalty.

Establishing and Funding a Self-Directed IRA

The process of establishing a Self-Directed IRA begins with selecting a specialized custodian. When choosing a custodian, it is important to consider their fee structure, experience with real estate investments, customer service, and their track record for IRS compliance and record-keeping. Some custodians may charge setup fees, annual recordkeeping fees, and transaction-specific fees, which can vary.

Once a custodian is chosen, opening the SDIRA account typically involves completing an application and providing identification. After the account is established, it needs to be funded.

Funds can be moved into the SDIRA through several methods. Direct contributions are permitted within annual IRS limits, which are $7,000 for 2025, with an additional $1,000 catch-up contribution for individuals aged 50 and over. Another common method is a rollover from an employer-sponsored retirement plan, such as a 401(k), 403(b), or 457 plan. Funds can also be transferred from an existing IRA held at another financial institution.

Executing Real Estate Investments through an IRA

Once a Self-Directed IRA is established and funded, the next step involves the actual acquisition of real estate. The IRA owner is responsible for identifying and vetting potential properties. While the owner directs the investment, they cannot personally manage the property or perform labor on it. This often necessitates engaging third-party professionals, such as real estate agents, property managers, and contractors, to handle various aspects of the investment.

Thorough due diligence is essential, as the SDIRA’s funds are at risk, not the individual’s personal assets. This involves researching the property’s value, potential income, and any associated risks. After a property is identified, the purchase process is facilitated by the SDIRA custodian. All transactions, including the earnest money deposit and the final purchase, must flow directly from the SDIRA. The title to the property will be held in the name of the SDIRA, for the benefit of the individual IRA owner, such as “Custodian for the Benefit of [Your Name] IRA.” The custodian is responsible for signing all legal documents related to the purchase and wiring funds.

Ongoing management of the real estate investment also adheres to strict SDIRA rules. All income generated by the property, such as rental payments, must be remitted directly to the SDIRA. Similarly, all expenses, including property taxes, insurance, and maintenance, must be paid from the SDIRA’s account. The IRA owner’s role remains passive and advisory; they cannot personally perform services or benefit directly from the property until distribution in retirement.

Tax Implications of IRA Real Estate Investing

Investing in real estate through an IRA maintains the inherent tax advantages of the retirement account. For a Traditional SDIRA, growth is tax-deferred, meaning taxes are paid only upon withdrawal in retirement. For a Roth SDIRA, contributions are made with after-tax dollars, and qualified withdrawals in retirement are entirely tax-free. This tax-advantaged growth can significantly enhance returns over time compared to personally owned real estate, where income and capital gains are taxed annually.

A significant tax consideration unique to SDIRA real estate is Unrelated Business Taxable Income (UBTI). UBTI can arise if the SDIRA engages in a trade or business that is regularly carried on, or if it uses debt-financing for the real estate purchase. For instance, if an SDIRA uses a non-recourse loan to acquire property, a portion of the income generated by that property, proportionate to the debt, may be subject to UBTI. The UBTI tax rate can be as high as the corporate tax rate, which is currently 21%.

While property taxes and other operating expenses must be paid from the SDIRA, these expenses reduce the net income within the SDIRA. If UBTI is incurred, these expenses can help offset the taxable income. However, typical real estate tax benefits like depreciation and interest write-offs (for recourse loans) are generally not personally available to the IRA owner, as the IRA is the legal owner of the property. When distributions are eventually taken from the SDIRA in retirement, they are taxed according to the rules of the specific IRA type (Traditional or Roth), regardless of the underlying real estate investment.