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Fresh alternative asset insights and the latest news on real estate and private equity investing.

Evaluating 4 Ways to Invest in Real Estate Using a Self-Directed IRA

Model House Resting on Calculator

  |  By Chris Shanahan, CISP®

Real estate is an attractive asset for many retirement savers. It is considered a long-term investment, which can correspond nicely with the longer time frame typically associated with retirement accounts, and investors can use self-directed IRA dollars, which provide tax advantages, to invest in real estate.

As PENSCO President Patrick Hughes discussed in a recent article for The Business Journals there are numerous ways that clients use self-directed IRAs to buy real estate. Not surprisingly, each method comes with its own unique opportunities as well as challenges. Below are four common ways that self-directed IRA owners use retirement account dollars for real estate investing, and the pros and cons that may be associated with each option:

1. Direct purchase: The IRA buys the entire property outright using funds in the account. Income and expenses flow directly in and out of the IRA.

  • Potential Pros: This is a streamlined method for investing in real estate. By purchasing property, a self-directed IRA owner does not need to take the time and expense to establish a company to purchase property indirectly through an LLC.
  • Potential Cons: All expenses, improvements and taxes related to the investment property must be paid directly from the IRA. This means the IRA owner must stay on top of all correspondence and paperwork, and ensure there is enough cash in the IRA to cover property-related expenses. Instead, for a fee, a property manager can handle paperwork related to the real estate including billing, collecting rent or paying expenses.

2. Partnerships or tenants-in-common purchase: These transactions combine an investor’s IRA funds either with funds from other investors or in conjunction with the IRA owner’s non-IRA funds. The investment income and expenses are handled proportionate to each entity’s ownership amount.

  • Potential Pros: This structure allows the IRA owner to purchase a property that he or she may not have otherwise been able to afford using IRA funds alone.
  • Potential Cons: If the IRA owner is partnering with a disqualified party, such as a spouse or child, the investment property is not eligible for financing.

3. Mortgage-backed purchase: In these purchases, the IRA borrows money to invest in real estate. Neither the IRA, nor the account owner, can have any personal liability in the mortgage, which means that investors cannot back their own loans. A non-recourse loan must be used so that the lender can only seize the property being purchased. All mortgage payments are made with IRA funds.

  • Potential Pros: A mortgage-backed purchase allows an IRA owner to leverage his or her IRA funds to invest in real estate. 
  • Potential Cons: If property purchased in an IRA is financed by debt, income produced by that investment property, as well as the gain on any sale, could produce unrelated business taxable income, or UBTI, and be subject to tax.

4. Limited liability company: In these transactions the property title is held in the name of the LLC. In this case, the IRA holds an interest in the LLC rather than title to the property.

  • Potential Pros: Investing in real estate in a self-directed IRA using an LLC provides IRA owners with the protection of an LLC while giving them a bit more flexibility in terms of investing. For example, the LLC can buy and sell properties without having to go through the self-directed IRA custodian each time.[1]
  • Potential Cons: Establishing an LLC involves more upfront time and expenses than buying an investment property directly. If the LLC is family controlled or established as a single member, an attorney or CPA needs to be put in place as a special advisor for the entity.

Real estate has the potential to yield long-term gains, and it can be attractive to investors looking for alternative assets to hold in their retirement accounts. But retirement savers should ensure they understand the rules of buying real estate with a self-directed IRA before making any purchasing decisions. Failing to follow IRS rules and regulations could lead to penalties or unexpected taxes.

It’s also crucial to conduct ample due diligence and work with a financial professional who has experience with holding real estate in an IRA before pursuing real estate investment opportunities.

To learn more about using your self-directed IRA to invest in real estate, please download our guide.

[1] Certain activity of an LLC may generate unrelated business taxable income for an IRA.  Please consult with a tax advisor for more information.

This Blog does not provide investment, tax, or legal advice nor does it evaluate, recommend or endorse any advisory firm or investment vehicle. Investments are not FDIC insured and are subject to risk, including the loss of principal.

PENSCO Trust Company performs the duties of an independent custodian of assets for self-directed individual and business retirement accounts and does not provide investment advice, sell investments or offer any tax or legal advice. Clients or potential clients are advised to perform their own due diligence in choosing any investment opportunity as well as selecting any professional to assist them with an investment opportunity.  Alternative investments are not FDIC insured and are subject to risk, including loss of principal.  PENSCO is indirectly affiliated with a registered broker dealer and with a licensed small business investment company through Opus Bank (“Opus Affiliates”).  Other than the Opus Affiliates, PENSCO is not affiliated with any financial professional, investment, investment sponsor, or investment, tax or legal advisor.