Using Self-Directed IRA for Real Estate Investments

by | Nov 10, 2023 | blog

Individual Retirement Accounts (IRAs)* are designed to provide a tax-advantaged space for individuals to save for retirement. A traditional IRA often limits the investor to more standard assets like stocks, bonds, or mutual funds. The self-directed IRA, on the other hand, broadens the horizon allowing you to invest in alternative investment assets such as mortgage notes.

Investing in real estate assets using a self-directed retirement account allows you to harness the growth potential of property while enjoying the tax benefits intrinsic to a retirement account. With the support of a knowledgeable self-directed IRA custodian, you can purchase and manage real estate assets for profit.

Today, we’ll take a look at how to effectively use a directed IRA for your property investment endeavors. This will include a look at how to set up the account, its benefits, and the regulations to adhere to. We’ll also discuss the common misconceptions about self-directed IRAs which are a challenge for new investors.

*7e Investments is not in the business of providing tax advice, Prior to investing in a tax-advantaged account, consult a tax professional. 

How to Set Up a Self-Directed IRA for Real Estate Investments

step-by-step guide for setting up a self-directed IRA

Using a directed IRA for real estate can offer you a suite of financial benefits. However, as with all investments, it’s essential to conduct thorough research and understand the intricacies of IRS regulations. Seek expert advice when necessary. Here’s a step-by-step guide for setting up a self-directed IRA.

1. Confirm Your Eligibility

Before you start, ensure you’re eligible to open a self-directed IRA. This involves assessing whether you have taxable income. If you’re considering a Roth IRA, make sure you fall under the specified income thresholds to qualify. On the other hand, while traditional IRAs don’t have contribution income limits, they might have income limits for tax deductions. For example, you should be able to distinguish the benefits of using a self-directed IRA for real estate from the tax-free growth potential in a Roth IRA or the tax-deferred growth in a traditional IRA.

2. Select a Reputable Self-Directed IRA Custodian

Your choice of custodian will make a difference in your real estate investment journey. Pick a custodian specializing in self-directed IRAs for real estate. They should have a deep understanding of the regulations that pertain to real estate investments within an IRA. Your custodian’s primary role is to hold the assets for you, manage the required record-keeping, and ensure all transactions adhere to IRS guidelines.

3. Initiate Your Self-Directed IRA Account

Once you’ve chosen a custodian, the next step is to set up your account. Fill out an application that with your personal details, financial information, and beneficiary designations. Another key aspect at this stage is to familiarize yourself with any fees associated with managing your account. Engage your custodian to find out whether they charge a flat annual fee or a tiered fee based on transactions or assets.

4. Transition Funds to Your New IRA

If you already possess an IRA, you can opt for a direct transfer, moving funds from one custodian to another without incurring taxes. If your funds are currently in an employer-sponsored plan, like a 401(k), you might consider a rollover. This method involves withdrawing money from the existing plan and depositing it into the self-directed IRA. It’s advisable to complete this process within 60 days to avoid any tax implications. Consult a financial advisor for professional oversight. 

5. Validate Your Account Setup

After you’ve transferred or rolled over the funds, double-check every step of the process. Reach out to your custodian to confirm that your account is active and correctly funded. Make it a habit to regularly review your account statements. Additionally, stay updated on IRS guidelines concerning self-directed IRAs and real estate to ensure compliance.

Benefits of Using a Directed IRA for Real Estate Investment

Tax Advantages

With a self-directed IRA, you can use your IRA funds to invest in real estate assets without incurring immediate tax liabilities on capital gains. Instead, income generated from these investments grows within the IRA tax-deferred allowing you to potentially build wealth more efficiently over time. Additionally, if the IRA is a Roth IRA, qualified distributions can ultimately be tax-free, providing a powerful wealth-building and retirement planning tool for those interested in real estate investing. 

Asset Diversification

When you add real estate assets to your IRA, you introduce a tangible asset to your retirement portfolio. Because the real estate market operates slightly differently than stock markets, such an investment can offer a layer of protection against volatile market shifts.

Potential for Greater Returns

Alternative assets like mortgage notes can also provide a steady stream of income from dividends that can be distributed monthly to investors. With proper due diligence and a sound strategy, your IRA investment in real estate can lead to the growth of your retirement account over time.

Direct Control Over Investments

A directed IRA real estate investment gives you direct control over where and how your money is invested. You can choose a specific property or asset, and select your preferred real estate company to invest with.

5 Common Misconceptions About Investing With Self-Directed IRAs

Common Misconceptions About Investing With Self-Directed IRAs

1. Self-Directed IRAs Are Expensive

Investors sometimes believe that the self-directed IRA cost is prohibitively high compared to a traditional retirement account. While there might be additional fees associated with alternative investments, the potential returns and diversification benefits can often outweigh these costs, especially when managed efficiently.

2. IRAs are Limited to Traditional Assets

A widespread misconception is that self-directed retirement accounts are limited to conventional assets like mutual funds or exchange-traded funds. In reality, self-directed accounts allow for a broad spectrum of investments, including real estate, precious metals, and even raw land. Real estate investors, in particular, can benefit from the diversity a self-directed account offers.

3. Real Estate IRA Rules Are the Same as Regular Purchases

Some real estate investors believe that a real estate purchase with an IRA is just like a regular real estate purchase. However, real estate IRA rules dictate specific guidelines. A real estate IRA custodian often helps navigate these rules to avoid prohibited transactions.

4. IRA Owners Can Freely Use Their IRA-Owned Properties

Another common misconception is that once a rental property is purchased through a self-directed IRA, the IRA owner or their family can use it. This is not accurate. Any property owned by the IRA must exclusively benefit the retirement account, and any personal use could be deemed as self-dealing, a prohibited transaction.

5. The IRA Owner Makes All Investment Decisions Alone

While it’s true that a self-directed IRA grants more control to the IRA account owners, it doesn’t mean they’re entirely on their own. Reputable real estate IRA custodians provide guidance, especially about prohibited transactions and compliance. However, they won’t provide specific investment advice, so investors should also consult financial professionals for that purpose.

Important Considerations & Rules to Follow When Investing With IRAs

Essential IRS Rules to Adhere to

  • Separation of Personal and IRA Funds: Keep personal funds separate from the self-directed IRA account. All expenses related to the investment property must be paid directly from your self-directed IRA. Similarly, rental income must flow directly back into this account.
  • Avoiding Prohibited Transactions: Engaging in transactions with a disqualified person or using the property for personal benefit can be deemed a prohibited transaction. For instance, neither the IRA holder nor their direct family can live in or use any property owned by the IRA.
  • Adhering to Financing Rules: If you choose to finance real estate through a self-directed IRA, the loan must be non-recourse. This means the IRA, not the individual, is responsible for the loan.

Diligence and Expert Consultation

  • Engage a Reliable IRA Custodian: An experienced self-directed IRA custodian will help you to navigate the intricacies of IRS regulations. They can guide you through the process, ensure all transactions are compliant, and manage the necessary record-keeping.
  • Consult a Financial Advisor: Real estate investing with a self-directed IRA has unique financial implications. Consult with a financial advisor to better understand tax benefits and potential liabilities

Would You Like to Invest in Real Estate Using a Self-Directed IRA?

We have seen that it is possible, and in some cases advantageous, to invest in real estate using a self-directed IRA. However, because of the complex nature of such funds, they usually come under a lot of scrutiny from the government. Please ensure that you follow all the rules and regulations that apply when investing.

CWS Investments specializes in alternative property investment by purchasing distressed mortgage notes for investment. You can use your self-directed IRA to invest in the fund with an aimed rate of 8 – 10% annualized return. We have a dedicated team of professionals who oversee our portfolio from over 40 US markets. You can invest with us from anywhere in the United States.

We buy distressed mortgage notes at a discounted price of about 40 – 60% of current market value and restructure new payments with the borrowers. Such margins allow us to put up better payment structures for the borrowers giving them a second chance to get their life back on track. Profits from the new payment structure are distributed monthly as dividends to investors. Would you like to invest in mortgage notes using your self-directed IRA? contact Chris Seveney and the CWS Investments team today.

Frequently Asked Questions about Self-Directed IRA for Real Estate

1. Can a self-directed IRA hold a mortgage?

Yes, it can. A self-directed IRA can hold a mortgage as part of its real estate investment strategies. This feature enables the holder to invest in mortgage notes, allowing income to flow into the IRA from mortgage repayments, and it’s a critical aspect of self-directed IRA real estate investments.

2. Why should you not use a self-directed IRA?

Opting not to use a self-directed IRA could be due to its complexity and the level of responsibility it requires from the investor. Managing a self-directed IRA for real estate, especially, necessitates a deeper understanding of the investment process and ongoing diligence to comply with IRS rules and regulations to avoid penalties. Some investors may prefer more traditional retirement accounts that do not involve the direct management of assets like real estate IRA investments.

3. Can a self-directed IRA invest in REIT?

Yes, a self-directed IRA can invest in Real Estate Investment Trusts (REITs). This investment approach allows IRA holders to invest in real estate indirectly, providing exposure to the real estate market while eliminating the need for direct property management, making it a viable option for those interested in real estate IRAs without direct property ownership responsibilities.

4. Does Fidelity offer self-directed IRA real estate?

Fidelity does offer self-directed IRAs; however, they generally do not allow for direct investments in real estate. Investors looking to use a self-directed IRA for real estate investments may need to explore other self-directed IRA custodians who specialize in real estate IRA and can facilitate such transactions, ensuring compliance with all applicable rules and regulations.

5. What is the penalty for a self-directed IRA?

Penalties for self-directed IRA non-compliance can be severe. If the IRS determines that there has been a prohibited transaction within a self-directed IRA real estate account, the account can lose its tax-advantaged status. The entire value of the IRA could become subject to income tax, and additional penalties may apply, especially if the IRA owner is under the age of 59½. It is crucial for investors to fully understand the rules governing real estate IRAs to avoid such penalties.