Learn How To Start Investing In Real Estate
Learn How To Start Investing In Real Estate

An Investor’s Guide To Self-Directed IRA In Real Estate

Written by Than Merrill

Resourceful investors can secure working capital in a countless number of ways. Some examples include conventional loans, private loans, and hard money lenders. However, even the savviest of investors can overlook an alternative source: their retirement accounts. Keep reading to find out why self-directed IRA real estate is a great tool to help finance your next investment.

What Is A Self-Directed IRA?

A self-directed IRA is a type of individual retirement account that can be used as an investment vehicle. The Internal Revenue Service (IRS) permits individuals to transfer retirement funds from a traditional retirement account into a self-directed IRA. Once that step is completed, the funds can be used to invest in several categories. One of the permitted investment options is real estate. Other options include stocks, partnerships, mortgage debt, and precious metals.

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Real estate ira

Self-Directed IRA Real Estate Rules

A self-directed IRA works much like a traditional retirement account, except for two things: more control and the ability to invest in alternative assets. This approach allows investors to direct how and where their money is invested. Naturally, this strategy incorporates a higher risk and will take considerably more work on the part of the investor, as most of the responsibility falls on them. However, it could pay off for those that do so wisely.
There are rules to abide by when using a self-directed retirement fund. The inability to follow these rules set forth by the IRS, will result in penalties––which could ultimately derail one’s retirement. That said, it is imperative individuals have a clear understanding of not only the financial landscape of their retirement savings but also the rules they must abide by.
The following represents some of the most important self-directed IRA real estate rules investors will be expected to follow:

  1. Cannot be used to purchase property owned by you or a disqualified person.

  2. Cannot have “indirect benefits.” This means any type of profits from the investment must provide for your retirement, whether now or at some future date. This indicates that investors cannot benefit from profits today or rent space from the building your self-directed IRA owns.

  3. Real estate can be acquired without 100 percent funding from the self-directed IRA.
    Investments that use financing must pay UBIT (unrelated business income tax).

  4. All expenses from investments (maintenance, improvements, and property taxes) must be paid from the IRA.

  5. All earned income goes back to the self-directed IRA.

How To Use A Self-Directed IRA To Finance Real Estate

The flexibility offered by self-directed IRA real estate has popularized it amongst investors. They can tap into their existing retirement savings to purchase rental properties, such as single or multi-family real estate. This is especially a wise choice if securing rental income from one or more properties will help you grow your retirement savings at a faster rate. Plus, many investors feel that they have more control over the outcome of their retirement investment funds by putting them in real estate.
If self directed IRA real estate sounds like a good fit, the first step is getting your account set up. Here the steps to help you get started:

  1. Begin The Paperwork

  2. Send Deposit

  3. Review The Documents

  4. Management

  5. Due Diligence

1. Begin The Paperwork

The first step to financing an investment property with a self-directed IRA is the paperwork. In most cases, this will begin with an investor locating a property, drawing up a purchase agreement, and agreeing to an earnest money deposit. However, it’s important to note that funds for the deposit must come from the IRA’s cash balance rather than their personal checking account.
When using a self-directed IRA, the next task is to sign all purchase contract documents, including the countersigning by an IRA custodian. Because IRS regulations require a custodian to hold the IRA assets on behalf of the self-directed owner, they will essentially perform the administrative duties, including any addenda or amendments to the purchase contract.

2. Send Deposit

The next component to consider is the deposit. IRA account owners will need to send the earnest money deposit funds to the title/escrow company using their IRA custodian. That said, it’s critical that sent funds are not from an IRA account owner’s personal account, as this will essentially constitute a prohibited transaction.

3. Review The Documents

This step will include the IRA custodian reviewing all documents to ensure the investment is suitable for administration, including no prohibited transactions. Known as the review process, this stage includes a preliminary title report for the property, a proposed grant deed, escrow instructions from the title/escrow company, a final settlement statement, and completed custodial forms.

4. Management

Once all the funds from the self-directed IRA are in escrow and documents have been signed (including the grant deed), investors can begin moving forward with their investment. At this stage, they are free to sell the property, rent it or lease it as they choose. However, according to the rules of self-directed IRAs, investors seeking to rent or lease a property are required to enlist a third-party property manager’s help to gather rental payments and forward them to the IRA. This process ensures all income from the property is paid to the IRA account.

5. Due Diligence

Like any investment in real estate, the importance of performing the necessary legwork in the beginning stages is critical to success. As a real estate investor, it’s critical that due diligence is always a check box on your to-do list, as this will essentially ensure you’re not sabotaging your investing efforts. In addition, when it comes to using self-directed IRAs to finance real estate, it’s crucial for investors to consult a tax professional before getting started.

Ira real estate

Pros & Cons Of Using A Self-Directed IRA For Real Estate

Now that you understand how to use your self-directed IRA for real estate, it’s time to decide whether or not it’s for you. In these next sections, we’ll go over the advantages and disadvantages of this strategy.
On one hand, the biggest advocates of self-directed IRA real estate say that they enjoy having more control over their retirement savings. On the other, some might caution that there are considerable restrictions. Keep reading to find out more.

Pros Of Self-Directed IRA For Real Estate

The key advantages of using a self-directed IRA for real estate pertain to having more control, which also opens up the possibility of earning higher returns. Other benefits include certain tax advantages and asset protection.

  • Authority: The most significant benefit of a self-directed IRA is control. Instead of earning subtle returns on typical retirement options like ETFs, mutual funds, bonds, and stocks, which are generally controlled by others, investors can choose alternative investments like real estate. Done correctly, this investment strategy can cultivate a significant nest egg for those looking to upgrade the financial conditions in retirement.

  • Tax Deferral: Another major benefit of a self-directed plan is the ability to grow your retirement savings in a tax-deferred or tax-free environment. This investment style enables individuals to reinvest profits from real estate investments, including rental income and capital gains, into other investments–tax-free. That said, it’s important to mention that tax deferral with a self directed-IRA only applies to the money you’ve attributed–and not any outside financing. For example, a property would need to be financed using funds from a self-directed IRA.

  • Although self-directed IRAs offer immense value in terms of tax deductions and deferral, individuals should consult a tax professional when in doubt.

  • Asset Protection: A self-directed IRA, like any other IRA, is afforded protection from federal and state bankruptcy law. By definition, it’s a trust, which means it is a separate entity from the owner and has its own set of asset protection. In return, this protects investors from creditors coming after them.

  • Higher Returns: The aim of using a self-directed IRA for real estate is to leverage your retirement savings to accrue a much larger nest egg at a much faster rate. Compared to traditional IRA investments, this approach can yield significant returns for investors, helping to further cushion retirement.

Cons Of Self-Directed IRA For Real Estate

Using a self-directed IRA to invest in real estate comes with a lot of responsibility. One of the advantages we discussed above was more control. However, having more control means that you’re partially responsible for the outcome. Understand what it takes to manage your retirement investments, as well as what restrictions you’ll face:

  • Approval: To take advantage of a self-directed IRA, a third-party custodian will be required. This account holder, which the IRS must approve, serves as an intermediary between the investor and the issuer of an investment, with the custodian having permission over the release of funds. Their job is to track and report contributions to and distributions from the account to the IRS. Because the custodian is simply a guardian of the account, they perform no diligence regarding investments.

  • Restrictions: The inability for self-dealing is another disadvantage of using a self-directed IRA. Generally speaking, those you have a 50 percent interest in, whether it be a spouse, immediate family member, or company, cannot be involved in any shape or form in the investment. These disqualified persons are unable to receive any benefits from investment transactions.

Self-Directed IRA Real Estate: What To Avoid

Besides knowing the pros and cons of self-directed IRA real estate, it’s also important to know what pitfalls to avoid.

First, following the rules is imperative. If you purchase an investment property incorrectly, your self-directed IRA can get disqualified. This results in a taxable event, thus making the opportunity to defer your taxes a moot point.

Second, be aware that if the property operates at a loss, you won’t be able to claim any tax breaks. You also won’t be able to claim any depreciation. Another potential tax issue is unrelated business income tax (UBIT). Make sure to consult your financial advisor or tax professional on what all this means and how you can minimize your tax liability. These financial stipulations must be considered before moving forward.

Next, make sure that you don’t plan on using your investment property for personal use. You might be tempted to convert the property into a vacation home or secondary residence, but you can’t. Per self-directed IRA rules, all real estate investments must be arm’s length transactions. This means that you cannot have any personal use for the property other than creating rental income from tenants.


While the real estate market offers a slew of financing options for investors, the use of a self-directed IRA for real estate lets you tap into capital you already have. It can be an invaluable tool for growing your retirement savings, as it gives you the freedom to choose how and where your retirement savings are invested. Real estate remains one of the most valuable, secure investments available, so being able to use your retirement account to invest in real estate is a win-win.
Have you tried setting up a self-directed IRA for real estate? Let us know in the comments below what your experience was like.

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