How to Use a Self-Directed IRA for Real Estate Investment

Saving for retirement doesn’t have to be difficult. More and more, IRAs are becoming the premier investment choice for personal investors, and with good reason. Many investors appreciate the familiarity of real estate investment; it’s a relatively straightforward process that offers far more stability than other riskier investments.


What is a self-directed IRA?

An IRA stands for an Individual Retirement Account (IRA). Available since 1974, it can be used for a number of investment purposes, such as precious metals and tax lien certificates.

While most IRAs are commonly used for stocks, bonds, and mutual funds, a Self-Directed IRA (SD-IRA) expands investment opportunities to include real estate, as well. It presents investors with a more flexible investment option with custodians generally more accepting to a wider variety of investment opportunities. Therefore, many investors utilize their Self-Directed IRA to purchase rental properties as an additional means of income.

The management of a Self-Directed IRA differs from traditional IRAs, however. The custodian cannot just be anyone; typically, it is a bank or credit union, or even a trust. Additionally, the custodian must be registered and maintained according to IRS regulations. There are split responsibilities for your investment. As the investor, you are responsible for the annual valuation of your investments, which you then report to your IRA custodian. With this information, the custodian can both maintain and report accurate records to the IRS.

As an individual, you are not the owner of the property; instead, the property is registered and owned by the IRA itself.


Why should I consider a self-directed IRA?

There are many different benefits to a self-directed IRA, but among the most notable are the incredible tax benefits when purchasing, renting, and flipping real estate.

Tax-deferred income offers investors the opportunity to enjoy no taxes or penalties until withdrawals are made from the account. In the meantime, investors are still able to buy, sell, and flip properties. A Roth Self-Directed IRA will ensure that both your profits and your investments remain tax-free, as long as you are older than 59.5 years of age when you withdraw funds. Otherwise, you may be subject to additional fees and penalties.

However, to continue to enjoy these tax benefits, investors must maintain their investments, either in current or new property.

The idea is for these IRAs to be self-sufficient, their fees and expenses covered by the incoming cash flow that your investments produce. Understandably, self-directed IRAs are very popular with real estate and investment professionals given their expertise, but many other investors enjoy significant gains, as well.


How do I use a self-directed IRA in real estate investments?

A Self-Directed IRA can be used for any number of properties like condominiums, apartment buildings, commercial structures, foreclosures, offshore properties, and even plots of land. Beyond property, a self-directed IRA can also apply to tax lien certificates, building bonds, leases, and trust or tangible asset deeds.

There are a few different options available when it comes to real estate IRAs:

1) Residential
Real Estate IRAs most popularly pertain to residential dwellings such as single-family homes, apartments, and condominiums.

2) Commerical
Commercial properties are wide-ranging, varying from retail shops to office structures.

3) Mortgage Notes
By becoming the financier of another’s purchase, you assume the role of a real estate lender and can set your own financing terms. With no responsibilities as far as tenant or property maintenance, you are free to enjoy regular, passive income. Mortgage notes may either be secured or unsecured. Unsecured notes, or promissory notes, are not supported by collateral and therefore present a much higher risk accompanied by more stringent provisions. When the loan is repaid, the debt is paid, and the promissory note conveys to the borrower.

4) Offshore Real Estate
Not all investors are interested in domestic properties, so foreign investments provide for international real estate purchases and can offer lucrative tax benefits. These types of investments require more diligence than others, given the introduction of international laws and regulations. Everything from the purchase process to the property title and even property management can all vary from country to country.

5) Real Estate Owned (REO) Properties
Real estate owned properties are foreclosures now owned by the bank. These are available for purchase through foreclosure, auction, or a direct sale from the bank. However, one wants to be sure that there are no existing property liens or conflicting legislation that could conflict with the transaction.

Residential and commercial properties serve to generate income from tenants and renters, but they come with the headaches of property and tenant management. Mortgage notes eliminate these heady duties but can present their own challenges in financing and loan repayment. Offshore real estate also presents its demands and limitations depending on the geographic location of the property, while real estate owned properties strike a bidding frenzy at auctions and foreclosures here on domestic soil.

Investments can be purchased with cash or financed through a non-recourse loan or investment partner.

When a Self-Directed IRA is used to purchase real estate, a non-recourse loan is used for financing. A non-recourse loan (also known as a non-recourse debt) uses collateral to secure the loan. The collateral serves as the liable party, not the borrower, so should you default on your loan, only the property is used for collateral.

However, your loan may fall subject to special taxes, such as the Unrelated Business Income Tax (UBIT) and its corresponding Unrelated Debt-Financed Income (UDFI). Under this provision, profits generated from certain assets, such as property, are subject to taxes.

A legitimate and reputable investment company will help you navigate IRS regulations and requirements. This help does not come free, so be sure to do your due diligence before committing to any particular custodian. Fees vary greatly, so it’s essential to get a clear picture of any added expenses.

What are the risks associated with a self-directed IRA?

Real estate is more demanding because it requires that all of your money is invested within a long-term strategy.

When approaching an investment, it’s imperative to properly screen each opportunity to determine its worth and value. It’s prudent to ensure that each investment is a fruitful one or your foray into investing will be a relatively short one.

Before making a purchase, investors should do their due diligence by performing a meticulous inspection of the property and thoroughly review all available records such as tenant history, past claims, and Homeowner’s Association guidelines.

No matter your background, investments require substantial research and expertise to know how and what to invest. For example, a misstep with a Roth IRA could surrender all tax benefits and leave you vulnerable to huge taxes and penalties that could be avoided. Also, if you purchase a property for your own use, or even that of a family member, you could surrender all benefits with your investment now considered a taxable event.

Liquidity could become an issue if you need access to your funds while they are tied up in a property. Depending on the stipulations of the sale, you may be unable to access distributions until the property is sold.

As the IRA owner, however, you are legally unable to act as a property manager or maintain and repair your property. Instead, these tasks are delegated to an experienced property management company that will handle these responsibilities on your behalf. The IRA covers these costs through the income generated from your tenants.

A Self-Directed IRA can present a lucrative opportunity to the seasoned and savvy investor, but it’s one that comes with responsibility. Well-informed investors can seize real estate and turn a significant profit when leveraged appropriately, with massive tax breaks and repayment terms that make for a generous payout.

There’s a reason why real estate continues to attract investors from all corners of the globe. With exclusive tax breaks and legal provisions, a Self-Directed IRA offers benefits and profits absent from other types of investments.
With a Self-Directed IRA, you are on track to an impressive and rewarding portfolio. It’s time to begin investing in your future.