Using a Self-Directed IRA to Invest in Real Estate

Given the stock market volatility we’ve seen over the past decade, many savers are finding that their retirement account balances aren’t where they want or need them to be. Some people are looking to expand their investment horizons beyond stocks, bonds, and mutual funds that have fallen in value, and would like to use funds from their IRAs to do so.

Unfortunately, Individual Retirement Accounts opened with traditional custodians (such as investment brokers and local banks) generally limit the types of investments IRA holders can make. A widely held but misconception is that the investment options offered by these traditional custodians are the only ones that are allowed.

In fact, there is a much broader range of investments allowed by the IRS. It is perfectly legal for an IRA holder to use its funds to invest in real estate, private debt instruments, and even certain types of precious metals. But because these other types of investments involve a greater administrative burden to manage, some IRA custodians have made the decision not to allow them in the accounts they protect.

The first step in using your IRA funds to invest in real estate is to find a custodian that will allow those investments. There are actually several different custodians that offer these accounts, which are generally known as “self-directed” IRAs. Again, it’s important to note that self-directed IRAs are no different than IRAs offered by traditional custodians: the difference is simply that a custodian of a self-directed IRA will allow the account holder to do the full range of investments that are allowed by the IRS, rather than limiting them to a subset of allowed investments. You will also need to determine whether to set up your self-directed IRA in the Traditional IRA or Roth IRA structure.

Different custodians will have different fee structures, so it’s important to compare them in light of the types of real estate you want to invest in. Some custodians may charge fees for each administrative activity they perform (which could get quite expensive if you plan to have several different properties within your account), while others charge a high but flat fee for your entire account (which could be too expensive if has only one property).

Once you’ve set up your new account, you should be aware of two important issues that affect all IRAs; the legal prohibitions on self-employment and unrelated business taxable income (or “UBTI”). The prohibition on self-trading means that you and your family cannot personally benefit from any assets within your IRA until you take those assets as a distribution. This means that if you have vacation property in your IRA, neither you nor any member of your family can use it; any personal use of the property could be construed as a de facto distribution and subject to immediate (and potentially substantial) loss. ) fiscal impact.

UBTI considerations come into play if you borrow money to buy real estate within your IRA. The IRA believes that this type of leverage is not sufficiently related to the tax-exempt status of your IRA, so that some of the income your IRA receives each year could impose an immediate tax liability on you personally.

Make sure you understand all the legal implications of using a self-directed IRA to invest in real estate, and only do business with a qualified and experienced custodian.