How to Buy Real Estate with a Self-Directed IRA

Real estate is one of the most popular alternative investments to hold in a SDIRA —and it’s easy to understand why. Owning real estate in a SDIRA can offer several potential benefits, including:

• Inflation protection: As a tangible asset, real estate tends to keep pace with inflation, helping to preserve purchasing power over time.
• Consistent income: Rental payments can provide a steady stream of income, which is especially valuable once the SDIRA account holder retires.

How to Buy Real Estate for Your SDIRA

To purchase real estate with a self-directed IRA (SDIRA), you must first have a custodian, such as Forge Trust, that is set up to hold alternative investments (of which real estate is one). When you make the purchase, your SDIRA—not you personally—is the buyer. To fund the transaction, you’ll need either sufficient funds within your SDIRA or a mortgage from a lender. Any mortgage must be non-recourse, meaning it can only be secured by the property itself, not by other assets in your SDIRA or personal assets.

Keep in mind that using a non-recourse loan to finance real estate in an IRA may result in Unrelated Business Income Tax (UBIT) on any Unrelated Debt Financed Income (UDFI) generated.

As with other SDIRA investments, you are responsible for identifying, evaluating, negotiating, and directing the purchase, although you may enlist the help of a real estate agent.

The Risks of Owning Real Estate in a SDIRA

Real estate can be a good investment—but it also has risks. As we saw during the 2007-2009 period, real estate can decline in value, especially if prices have risen rapidly. Even if the national real estate market doesn’t tank, that doesn’t mean certain local markets will hold their value. For example, a town or city experiencing population decline will also tend to see real estate values fall given that demand for housing is falling.

Another risk inherent with real estate is that it can be quite illiquid (meaning it cannot be turned into cash quickly). What’s particularly problematic about this is that real estate tends to be most illiquid when prices are falling—because there’s often more sellers than there are buyers. As a result, a property can sit on the market for an extended period of time—which isn’t great if you need cash in short order.

Opening the Right Self-Directed IRA to Buy Real Estate

It’s important to open the right kind of SDIRA if you’re thinking of buying real estate to save for your retirement. For most people, a Traditional Individual IRA or a Roth IRA is the appropriate choice. However, in some cases, other kinds of SDIRAs may be better suited to someone’s situation.

As we discussed in a prior article, some self-directed investors opt to create a single-member LLC, often called a Real Estate LLC, IRA LLC, or Checkbook Control LLC. This structure allows the IRA account owner to act swiftly on investment opportunities and manage rental properties more efficiently.

Specialized facilitators can help set up and maintain a Single Member LLC, though there are associated costs. Before proceeding, it's important for investors to evaluate whether establishing a single-member LLC is a cost-effective strategy for their specific needs.

Real Estate in a SDIRA: Rules and Regulations

Real estate held in an SDIRA is subject to strict regulations, and violating these can result in significant consequences. The last thing you want is to get on the wrong side of the IRS!

The most important rule is that you cannot personally benefit from the real estate purchased through your SDIRA. While you can enjoy the growth in value of your real estate, you cannot live on the property, use it as a second home, use it as collateral for a personal loan, or spend any income generated by the property for non-SDIRA purposes.

This restriction extends to “Disqualified Persons,” which includes your parents, spouse, children, their spouses, and any fiduciary or service provider for the account.

Additional rules for real estate SDIRAs include:

• You must personally handle identifying, evaluating, and negotiating the purchase of real estate, although you can use a real estate agent.
• All income and expenses related to the property must flow through the SDIRA
• Any necessary maintenance must be performed by an arms-length third-party. You cannot personally perform any work on the property owned by your SDIRA.

Selling Real Estate in a Self-Directed IRA

At some point, you may decide it’s time to part with a property held in your Self-Directed IRA. A sale of your SDIRA real estate works in much the same way as the purchase:

• The seller of the property is technically your self-directed IRA
• You can use a real estate agent, but ultimately you are the person responsible for negotiating the sale and closing the transaction
• The funds received upon closing will be sent to your SDIRA (withdrawing any proceeds from the account could result in tax consequences)

Conclusion

Real estate is one of the most popular alternative investments, given its potential for capital appreciation and steady income. Add in the possible tax advantages of owning property in a SDIRA and it’s easy to see why so many Americans invest in real estate for their retirement.