How to Invest in Real Estate With a Self-Directed IRA

Should You Buy Real Estate in an IRA?

What to Know About the Self-Directed IRA: Self-directed IRAs offer non-traditional investments other than the usual stocks, bonds, ETFs, mutual funds, and CDs—like real estate investments and livestock It’s vital to accurately value your investment every year and report the value to your IRA custodian Make sure to examine all of the potential fees and expenses that will impact the overall return on your investment One risk is not being able to access the value of your investment to make distributions when you may need the money the most during your retirement years

Image by Brianna Gilmartin © The Balance 2020

A growing number of retirement savers are becoming aware that they can choose investments other than the traditional offerings of stocks, bonds, mutual funds, ETFs, and CDs within an Individual Retirement Account (IRA).

Self-directed IRAs (SD-IRA) allow you to invest in real estate, precious metals, notes, tax lien certificates, private placements, and many more investment options.

However, that doesn't necessarily mean it's the best choice for your retirement savings. Here are some important things to be aware of when it comes to using an IRA to purchase real estate.

What Is a Self-Directed IRA?

A self-directed IRA is a traditional IRA or Roth IRA in which the custodian permits a wide range of investments that are allowable in retirement accounts. One of these alternative options—real estate investments—is appealing to many people who consider using a self-directed IRA to purchase rental properties.


The term “self-directed” means that alternative investments are accepted or offered by the IRA custodian.

An IRA custodian is the financial institution responsible for record-keeping and IRS reporting requirements. Each year, you must accurately value your investment and report the value to your IRA custodian—this is where the "self-directed" aspect comes in.

Buying Real Estate With a Self-Directed IRA

If you're looking to buy real estate with a self-directed IRA, you'll first need to set up the account. Several reputable companies provide individual investors with the ability to set up self-directed retirement accounts on their own.

However, due to the complex nature of self-directed IRAs, it is helpful to have a custodian that will provide some much-needed guidance as you work your way through the IRS tax code.

Some IRA custodians have more complicated fee structures than others. Therefore, it is important to do your homework and examine all of the potential fees and expenses that will impact the overall return on your investment.

In many cases, it is also advisable to establish a limited liability company (LLC) or other entity to hold the investment assets.

With self-directed IRAs, you must generate sufficient cash flow that will cover all maintenance and repair costs without the need for you to add cash each year.

Benefits of Owning Investment Real Estate in an IRA

Perhaps the biggest benefit of using a self-directed IRA to purchase real estate is found in the potential tax benefits. As is the case with any investment in your IRA, you benefit from tax-deferred income until the day you take withdrawals.

Or, if your investment holdings are in a Roth IRA, your investment gains accumulate tax-free, and you can withdraw it tax-free.

You still must wait until you reach age 59 1/2 to withdraw your funds, or else you will be subject to an early withdrawal penalty. That withdrawal will be included as ordinary income on your tax return.

However, active investors may buy, sell, or flip properties and move funds from one project to another while maintaining the tax-deferral status of the IRA.

Another benefit of owning real estate in an IRA is familiarity. Investor interest is often sparked by global market uncertainty, and this can lead investors to stick with more local investments. Self-directed IRAs provide you with the ability to invest in investments that you know and understand.

Potential Downsides and Risks

As an account holder in a self-directed IRA, you are responsible for doing the required due diligence on the property itself. This may be an appealing feature of real estate investing in IRAs if you are a real estate professional or experienced investor.

However, if you are not a savvy real estate investor, it could easily lead to a bad investment decision or leave you vulnerable to fraud. The Securities and Exchange Commission has released an investor alert addressing self-directed IRAs and the risk of fraud.

One of the biggest risks of owning real estate in a self-directed IRA is the potential lack of diversification. Many investors lack the cash needed to create a diversified real estate investment portfolio.


Only focusing on the upside potential is a major risk to consider before purchasing an investment property.

Liquidity is another big concern when investing in real estate within an IRA. There is always a possibility that you may not be able to access the value of your investment to make distributions if you need the money during your retirement years.

Self-Directed IRA Tax Pitfalls to Avoid

Owning real estate in an IRA allows your investment to grow on a tax-deferred basis, though Roth IRAs provide the potential for tax-free growth.

However, if you don’t follow the rules, you could purchase a property the wrong way, disqualify the IRA, and create a taxable event.

IRA ownership of investment property also loses some of the tax breaks available to real estate investors if the property operates at a loss. You also cannot claim depreciation on IRA-owned real estate.

If you plan on using an IRA to purchase a vacation home or a primary or secondary residence, think again. Self-directed IRA investment transactions involving real estate must all be arm's length transactions.

That means that no self-dealing or personal transactions are allowable with self-directed IRAs. This rule also applies to immediate family members. If you buy a property from or sell a property to a family member (or yourself), you will create a taxable event.

Unrelated business income tax (UBIT) is another potential tax issue. It will be especially important to pay attention to this tax if you are thinking about using a mortgage to purchase an investment property.

With a traditional IRA, you must take required minimum distributions once you reach age 70 1/2. If you own real estate in an IRA, it is very difficult to sell off your real estate holdings in small chunks each year. For that reason, you must keep enough cash in your IRA accounts to cover your required distributions, or else you'll run into tax problems.