Can I Use a Self-Directed IRA for Real Estate Investing?

For some people, a self-directed IRA could be a great vehicle to invest tax-advantaged retirement funds in real property. However, there are rules governing everything from property ownership and usage to how you cover expenses and take profits. If you don’t follow them, you can quickly run afoul of the IRS.

Forbes’ recent article “How To Use A Self-Directed IRA For Real Estate Investing” explains that a real estate IRA is just another name for a self-directed IRA designed to hold investment property. You can own many property types in a real estate IRA. This includes land, single and multi-family homes, international property, boat docks, commercial properties, and more. Because this is a self-directed IRA, the custodian—the company safeguarding your account and enforcing IRS regulations—allows you to hold alternative asset classes, like real estate.

First, find a custodian who allows or specializes in real estate IRAs. Next, you must fund your account—typically with a rollover from an existing IRA. With your cash in place, you can buy real estate and have it titled in the name of your IRA. You can finance real estate in your IRA with an investment property-specific mortgage. You can then pay the mortgage using additional cash from your self-directed IRA. When you sell a property held in a real estate IRA, the funds stay in the account. Depending on the type of IRA you’ve selected, those funds grow tax-deferred (traditional IRA) or tax-free (Roth IRA).

A real estate IRA allows you to diversify away from stocks and bonds. However, there are many rules governing this specialized type of account. Let’s look at some of the critical rules you must know:

Property Title. The account, rather than you own the real estate held in a self-directed IRA. Therefore, the title documents that confirm ownership of the property are in the name of your IRA rather than in your name.

Expenses and Income. All expenses and income flow into and out of your real estate IRA. Your account pays all property taxes, utility bills, and other costs. All rental income or other income is paid back into your account.

Limitations on Use. Real estate held in a self-directed IRA can only be an investment property. You and any family member—plus any of your beneficiaries or fiduciaries—are disqualified persons. Since the purpose of an IRA is retirement investing, these disqualified persons can’t use the real estate assets.

No DIY. If you need to fix up or repair property held in a real estate IRA, the account must pay for the work. You cannot perform that work because you are a disqualified person.

Prior Property Ownership. You can’t sell, lease, or exchange property you already own to your real estate IRA. That’s called “self-dealing,” which the IRS strictly prohibits.

Watch Out for the UBIT. If you take out a loan secured by the property itself (a non-recourse loan), you will be required to pay unrelated business income tax (UBIT) on any profits related to the financed portion. However, you can use depreciation and operating costs to reduce your tax bill, allowing you to reduce your UBIT or eliminate it altogether.

Reference: Forbes (Feb. 13, 2023) “How To Use A Self-Directed IRA For Real Estate Investing”