What is a Self-Directed IRA for Real Estate?
Self-directed IRAs (SDIRAs) allow retirement savers to own a broad array of investments. Unlike a regular IRA, a SDIRA gives individuals the ability to hold so-called alternative assets, in addition to more traditional investments like stocks, bonds, and mutual funds. Among alternative assets, real estate continues to be a popular choice among investors.
How Does Holding Real Estate in my IRA Work?
Here’s how self-directed IRA real estate investing works. First, you need a custodian (such as Forge Trust) to administer the account, because technically the buyer of a property will be the SDIRA itself (as opposed to you, personally). Next, the SDIRA must be funded so it can purchase the real estate. If you don’t have enough funds in your account (and lack the ability to contribute more), you’ll have to get a mortgage. Keep in mind that any loan you obtain must be non-recourse, meaning it can only be secured by the property itself, and you will need to put down 30-40% of the purchase price, depending on the type of real estate.
Types of Real Estate Investments Allowed in SDIRAs
The IRS permits retirement savers to hold many types of real estate in a self-directed IRA—so long as they are purchased strictly for investment purposes only.
Common SDIRA 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
- Mineral rights
- New construction and development
- Vacant land
- Resorts and hotels
Benefits of Using a Self-Directed IRA for Real Estate
Many retirement savers gravitate to investment real estate for their self-directed IRA. Real estate held in a SDIRA may deliver many important benefits to an individual. Key potential advantages to owning real estate in a self-directed IRA include:
- Protection from inflation: As a tangible asset, real estate may keep track with the rate of inflation, thereby helping to maintain a saver’s purchasing power
- Steady income: Ongoing rental payments could mean consistent income, which may be of particular importance when a SDIRA account holder is no longer working
- Tax-advantaged: Whether it’s held in a traditional or Roth SDIRA, income from investment real estate may grow on a tax-deferred basis..
Rules and Regulations Governing Real Estate SDIRAs
When it comes to real estate SDIRAs it’s crucial to stay on the right side of the IRS. Self-directed IRA real estate is subject to various rules and regulations—and violating these can lead to both penalties and headaches.
The most important rule is that you cannot personally benefit from the real estate purchased as an investment in your SDIRA. In practice, this means you cannot live on the property (i.e. treat it like a second home), use it as collateral for a personal loan, or use funds generated by the property for purposes unrelated to your SDIRA.
This prohibition against personally benefitting from investment real estate extends to what the IRS deems “ Disqualified Persons ”: your parents, spouse, children, and their spouses, in addition to any fiduciary or service provider to the account.
Other rules regarding real estate SDIRAs include:
- Any work to identify, evaluate, and negotiate the purchase of real estate must be done by you. You are, however, allowed to use the services of a real estate agent.
- All income and expenses related to a property must be received and paid by the SDIRA itself. Many will use the assistance of a Property Management Company.
- Any required maintenance must be performed by a third party
Challenges and Risks
SDIRA real estate investing is not all sunshine and roses. There can be significant risks and challenges along the way. Identifying a compelling investment property may not be easy, for starters. What’s more, the value of real estate can fluctuate considerably, and the property you purchase could decline in value. Another risk is that any rental income may fall short of your expectations.
Real estate, unlike publicly traded stocks and bonds, can be quite illiquid, which presents an added risk. Liquidity is the ability to quickly cash out of an investment at or near the most recent market price. In real estate market downturns liquidity tends to dry up—meaning you may not find a buyer for your SDIRA property without a substantial price reduction.
Conclusion
If you’re interested in buying real estate for your self-directed IRA, you’re not alone. Many investors use their SDIRAs to hold investment properties for the potential benefits they can bring. As with any investment, however, understanding SDIRA real estate rules, regulations, and risks is crucial before making any purchases.
Learn more about holding real estate in a Forge Trust IRA.
Frequently Asked Questions About Real Estate SDIRAS
How do I purchase real estate with a Self-directed IRA?
First, you need a custodian (such as Forge Trust) to administer the account, because technically the buyer of a property will be the SDIRA itself (as opposed to you, personally). Next, the SDIRA must be funded so it can purchase the real estate. If you don’t have enough funds in your account (and lack the ability to contribute more), you’ll have to get a non-recourse mortgage.
What are the potential tax advantages of investing in real estate through a Self-Directed IRA?
With a Traditional Real Estate IRA, your contributions may be made with pre-tax dollars and thus, reduce your taxable income, subject to IRS limitations. (Contributions to traditional IRAs are not always tax-deductible: If you have an employer retirement plan, for example, there are limits to deductibility). When the real estate is in the account, it has the potential
to appreciate on a tax-free basis. Meanwhile, Roth Real Estate IRAs allow for tax-free growth, and money can be taken out of them tax-free when you do a qualified withdrawal.
Are there any restrictions on the type of real estate I can purchase with a Self-Directed IRA?
You can purchase a wide range of real estate with a Self-Directed IRA. Permitted kinds of SDIRA real estate investments 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
- Mineral rights
- New construction and development
- Vacant land
- Resorts and hotels
What other rules and regulations should I be aware of when it comes to real estate SDIRAs?
The most important rule is that you cannot personally benefit from the real estate purchased as an investment in your SDIRA. In practice, this means you cannot live on the property (i.e. treat it like a second home), use it as collateral for a personal loan, or use funds generated by the property for purposes unrelated to your SDIRA.
Other rules regarding real estate SDIRAs include:
- Any work to identify, evaluate, and negotiate the purchase of real estate must be done by you. You are, however, allowed to use the services of a real estate agent.
- All income and expenses related to a property must be received and paid by the SDIRA itself.
- Any required maintenance must be performed by a third party
Zander is a seasoned product leader with a 12-year history in financial technology, specializing in private market investments. His tenure includes roles at LTSE, Alto, and IHS Markit, where he focused on product management and strategy. Zander holds an MBA from Vanderbilt University, focusing on International Business, and a B.A. in Economics from Colby College.