Can You Invest in Real Estate with a Self-Directed IRA?

When it comes to saving for retirement, many Americans seek the freedom offered by a Self-Directed IRA (SDIRA). Compared to regular IRAs, SDIRAs allow individuals to hold a much broader array of investments. Specifically, with a SDIRA, you can own alternative assets in addition to stocks, bonds, and mutual funds. Alternative assets have the potential for higher returns than publicly traded stocks or bonds, though they often come with more risk than “regular” investments. Alternative assets also may offer compelling diversification benefits to an investor’s portfolio, as they aren’t always correlated with public stock and bond markets.

Investment real estate is a popular alternative asset to hold in a SDIRA.¹ Real estate is a familiar and tangible asset that can be evaluated as a potential SDIRA investment. Below we explain what real estate investing entails and how it works within a SDIRA.

What is Real Estate Investing?

Real estate investing is the purchase of property with the goal of income generation and/or capital appreciation. Common real estate investment options include:

• Homes, condominiums, and apartments
• Commercial properties, such as malls, stores, and office buildings
• Real Estate Investment Trusts (REITs)
• Trust deed notes, mortgages, and tax liens
• Farmland
• Timber, water, or mineral rights
• New construction and development
• Vacant land
• Resorts and hotels

Most investment real estate is privately held (think farmland, or a single-family homes). Some real estate investments, however, are publicly traded, such as Real Estate Investment Trusts (REITs). Usually structured as mutual funds or exchange-traded funds, but occasionally existing in private vehicles, REITs own one or more investment properties and must distribute at least 90% of their taxable income in the form of shareholder dividends each year.²

While Self-Directed (and regular) IRAs may hold REITs, when we’re talking about real estate investments for SDIRAs below, we’re usually referring to direct ownership of real estate.

The Potential Risks and Rewards of SDIRA Real Estate

Investing in real estate comes with many potential rewards. For starters, as a tangible asset, real estate may provide investors protection from inflation. While “paper” assets (such as corporate or government bonds) can see their value eroded by inflation, the price of tangible assets like real estate may rise.

Investing in real estate has the potential to deliver ongoing, predictable income, which can be of paramount importance to someone once they’ve retired. Whether from owning an apartment complex or an office building, rental income can produce much-needed cash flow to sustain a retiree’s desired lifestyle.

Of course, as with any investment, there are risks to real estate investing. A property may lose value, whether due to economy-wide factors such as rising interest rates or trends like the shift to remote work, or issues specific to a particular city or town (a declining population, for example), or issues specific to a particular piece of real estate. Another risk is that income may fall short of what you expect, either because tenants fall behind on rent, or you’re unable to fill vacant units.

Another potential risk is that real estate is less liquid compared to exchange-traded assets like stocks. That means you may not be able to quickly sell a property if you need to cash out quickly. For example, real estate deals can take weeks or even months to close, with an average of 44 days for residential transactions as of September 2023.³

How Investing in Real Estate with a SDIRA Works

To buy real estate with a SDIRA, you first need to have a custodian (such as Forge Trust) to administer your account. When you make the purchase, it’s the SDIRA itself that is the buyer (as opposed to you, as an individual). To fund the transaction, you either need to have sufficient funds in your SDIRA or obtain a mortgage from a lender. Any mortgage you obtain must be non-recourse: it can only be secured by the named property, not other assets held by the SDIRA, or other assets you own. These mortgages often require more than the traditional 20% down payment.

Rules for Real Estate Investing in a SDIRA

Anyone with a SDIRA may invest in real estate. But to stay on the right side of the IRS rules for real estate investing in a SDIRA, it’s crucial to be aware of prohibited transactions and other guidelines.⁴

The most important rule is that the SDIRA account holder cannot benefit in any way from an investment property. Here’s what that means:

• You cannot live on the property or treat it like a second home.
• You also may not use the property as collateral for a personal loan, use funds generated from the investment to pay off unrelated debts, or pay off a mortgage on your primary residence.
• Certain people are considered “Disqualified Persons,” and they are also ineligible to reap any benefits from the investment property. Disqualified Persons include your parents, spouse, children, and their spouses, in addition to any fiduciary or service provider to the account.⁵

In addition to the prohibition against personally benefitting from a property, here are other rules to be aware of if you’re considering real estate for an SDIRA:

• You are responsible for identifying, evaluating, negotiating, and directing an IRA real estate purchase (though you may use the services of a real estate agent).
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• All income related to the property must be paid directly to the SDIRA custodian to be deposited in the owner’s account.
• All expenses related to an investment property must be paid by the SDIRA. You cannot personally write a check to a landscaper, for instance.
• Any maintenance required on a property held by the SDIRA must be completed by a third party.

Conclusion

If real estate investing appeals to you as part of your retirement plan, a SDIRA can provide a way for you to make that investment in a tax-advantaged way. But it’s important to know all the rules and regulations of investment real estate before you take the plunge.

For investors interested in learning more, go to forgetrust.com.