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How to invest in Real Estate with a Self-Directed IRA

A self-directed IRA ("SDIRA") is an investment account where the custodian allows you (the beneficiary) to invest in any investment permitted by law. A custodian is a financial institution that keeps investments in an account and ensures that all IRS and government regulations are complied with. An SDIRA can take many forms, including a Traditional or ROTH. Investments can be allocated to private real estate, cryptocurrency, notes, metals, venture investments, or private company shares.

While you may be scratching your head asking yourself, why haven't I heard about a SDIRA? Why have I only seen the option to invest in stocks, bonds, and mutual funds in my retirement account? This article will cover the potential benefits of self-directing your investment using a retirement account.

What are the tax benefits of investing in a retirement account?

Both a ROTH and Traditional IRA allow your assets to grow tax-deferred. Said differently, no taxes are paid on dividends or capital gains on the investment until distributions are taken. The main difference between a ROTH and Traditional IRA is when you get a tax break. With a ROTH IRA, your contributions are made with after-tax dollars. Conversely, Traditional IRA upfront contributions are typically tax-deductible, but withdrawals are not tax-free.

The maximum allowable IRA contribution limit for 2021 is $6,000, or $7,000 if you are 50 years old or older.

While it's essential to consult a CPA or financial advisor, there are potential benefits of contributing to a ROTH IRA when your marginal tax rate is lower. This might be the case if you are starting your career and your salary is the lowest. Additionally, it's worth an audit of where the current marginal tax rate is compared to the historical average.

SDIRA factors to consider

Withdrawing from your Traditional IRA before age 59.5 will typically trigger payment of taxes and an additional 10% withdrawal penalty. For Traditional IRAs, required minimum distributions ("RMD") start at age 72 otherwise, penalties are owed to the IRS. With a ROTH IRA, which also do have early withdrawal penalties, there is no RMD and your investment can compound tax-free in perpetuity.

How to set-up an SDIRA?

Inherently individuals are limited to investments offered by their company's retirement account. For example, if you log in to your retirement plan web portal, you will see a limited menu of options. As mentioned earlier, a custodian's role is to provide you with any investment allowed by law, which means that the restriction to invest in alternative investments is a business decision, not a legal one. Therefore, your ability to self-direct your retirement funds depends on whether you can rollover or transfer your capital to a custodian that allows you to self-direct your IRA. It's worth noting, as mentioned above, withdrawing funds (different than transferring funds to another retirement account) will trigger a tax event if you are less than 59.5 years old.

So how can you set-up an SDIRA that provides you a more expansive breadth of options, such as private real estate investments? If you have a 401(k) with a current employer, then there are restrictions to rolling over to an SDIRA while employed. Most firms want to keep employees' funds at preselected retirement accounts. If you decide to leave your employer, you can rollover to a self-directed IRA. Additionally, if you have been making contributions to a bank or brokerage IRA, you can transfer the funds to SDIRA.

How to purchase alternative investments with your SDIRA?

An investment must be held in the name of the SDIRA custodian and not by the individual (beneficiary) to qualify for the tax benefits mentioned above. When a subscription document is completed for participation in a direct investment or Fund, the investment should be named: XYZ Trust Company, [for the benefit of] FBO John Doe, Account # 1234567. Next, we will outline the steps necessary to complete purchasing real estate with your self-directed IRA.

Example SDIRA Investment in a Fund
Example SDIRA Investment in a Fund

Once you have selected a custodian of your choice who allows access to alternative investments, funded self-directed IRA account is the next step. Upon reviewing several investment offerings suitable to your risk tolerance and investment time horizon, take the next step by filling out your subscription document. After indicating your interest in an investment, a Private Placement Purchase Direction form will need to be completed. It’s important to note, custodians often times have different naming conventions for the Private Placement Purchase Direction form, which contains information such as account owner's information, investment information (i.e. initial purchase or additional purchase), purchase funding instructions (or alternatively, for a sale or exchange), and account owner's acknowledgment and signature. This form will give authority for your custodian to purchase an interest in the direct investment or Fund on your behalf. At that point, the custodian reviews the Sponsor's subscription document and The Private Placement Purchase Direction form to approve this investment is allowable by law. The custodian signs the Private Placement Purchase Direction and proceeds to execute the investment. Any potential distributions or profit from the sale of the investment must returned to the beneficiary’s account. Otherwise, a taxable event will be triggered.

What are some considerations for holding real estate in an SDIRA?

There are many tax benefits to owning tangible real estate in a retirement account however, investors need to understand potential risks. Outlined below are a few considerations to owning private real estate with your SDIRA:

  • You cannot purchase a property or an interest in a direct investment in commercial real estate, or fund, from a disqualified person. A disqualified person is your spouse, parents, grandparents, children, or grandchildren. Purchasing or selling a property to a disqualified person is called self-dealing and carries stiff penalties.
  • Real estate must be held for investment purposes. Therefore, you nor a relative can occupy the property.
  • If there is a loan on the property, the loan must be non-recourse to the IRA's beneficiary.
  • The IRA owner can oversee the property's management but he/she is prohibited from actually working on the property itself.
  • Some types of real estate investments are deemed trade or business activity and subject to Unrelated Business Tax Income. Examples of these investments include ground-up development, hospitality businesses, and real estate held for short-term profit (i.e. flipping).

Due Diligence on an SDIRA Custodian

When it comes to investing with your self-directed IRA, do your homework on the investment products. The custodian is not vetting the Sponsor's track record, risk profile, hypothetical anticipated returns, and how this investment maps to your overall investment strategy. The SDIRA custodian is merely asserting the investment is legal based on the paperwork you have provided.

SDIRA Due diligence

Communication and back-office customer support are paramount to ensure no unexpected tax events. At times, investing in a real estate syndication may only allow a small window of time to fund the investment before closing occurs or investment is no longer available. Additionally, SDIRA custodians must provide fair market value (FMV) to the government of all retirement accounts annually. In most cases, this will be provided by the issuer Sponsor for your annual tax filings, however investors must maintain visibility of this process.

Self-directed IRA fees typically fall into two categories: asset-based or a flat fee. An asset-based fee is a percentage of the total assets under management of an investor's portfolio. Many firms offer a tiered structure, where the fee percentage compresses as your portfolio AUM increases. These fees are generally paid once a year. With a flat fee, the custodian typically charges a fee each year or quarter based on the number of investments you have in your account. There is usually a set-up fee to start an SDIRA account in both cases, which varies with each custodian.


Ultimately, an SDIRA puts you in control of your investment decisions. Anecdotally, the PayPal co-founder, Peter Thiel used his ROTH SDIRA to invest in Facebook in 2004 before it went public. As long as Peter withdraws the profits after he is 59.5 years old, the gain is 100% tax free.

While it's essential to consult a Certified Public Accountant when considering the tax implications on your investment, an SDIRA (Traditional or ROTH) is a tax-advantaged account that allows more discretion to allocate your retirement assets. Historically, financial institutions only offered stocks, bonds and mutual funds to investors within a retirement plan. You can now add commercial real estate to these retirement accounts, which may make sense as part of a longer-term retirement portfolio allocation. Before you invest, it is essential to educate yourself on IRA guidelines and investing in alternative assets.

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