The Self-Directed IRA - Real Estate Investments

The self-directed IRA allows individuals to invest retirement funds in real estate focused assets. We’re seeing more investors utilize this unique investment vehicle and we can help you get started with this guide. We’ll go over the benefits of the self-directed IRA, what to watch out for and how to start investing. But first, let’s understand the history of the self-directed IRA.

The Rise of The Self-Directed IRA

The traditional IRA rose in popularity during the 1990s. However, investors were limited to traditional investments. These included stocks, bonds and mutual funds. By the 2000s the self-directed IRA gained popularity. It allowed investing in alternative assets including real estate. Today, the IRA is innovating even more with online platforms for accessing high-yield private investments.    

Four Self-Directed IRA Benefits

1. Diversification- Portfolio diversification is the obvious benefit offered by this product. Some investors find real estate to be a higher yield investment. Plus, some prefer real estate as a tangible asset. Even within the real estate category, investors can diversify with several types of real estate categories.

Here is a breakdown of the main real estate categories allowed by the self-directed IRA:

  • Commercial property - Includes retail space, office buildings, storage units and industrial properties.
  • Residential - Includes single family homes or multi-family complexes (apartments and condos).
  • Real estate notes - Includes mortgage notes and trust deeds.
  • Land - Includes raw land for farming, logging or for sale to future developers.

2. Flexibility - Using a self-directed IRA for investing in some of the assets mentioned above gives investors the freedom to invest in opportunities as they arise. Investors also have the freedom to choose whether to flip or rent out their property. Finally, investors can invest or divest funds in multiple properties as they wish. Plus, self-directed IRA services now exist to make these transactions online-based and even more flexible.

3. Tax Benefits - One of the biggest advantages of using the self-directed IRA for real estate is the tax benefits. Instead of immediately owing taxes on investment gains, the tax is delayed. We’ve seen investors reinvest these funds or allow them to grow for decades. Either way, taxes are only applied at a later date when funds are dispersed. Plus, with a Roth IRA gains aren’t taxed at all.

4. Hedge Against Market Fluctuations - Real estate can provide a hedge against market volatility. When global market insecurities emerge, investors can benefit from having local and familiar investments. Also, real estate of all categories are a tangible asset. This in itself can create more certainty for the investor. All these factors contribute to making real estate a viable option for portfolio diversification.

Pitfalls to Avoid

In order to enjoy the full tax benefits of the self-directed IRA real estate investment, be aware of “self-dealing” rules. In general, these rules prohibit dealings between the IRA owner or his family members/spouse and the IRA account. For instance, an investor can’t buy a property owned under his self-directed IRA. An investor also can’t rent out one of his IRA owned investment properties to a family member. These transactions would result in an unfair double benefit to the IRA owner. Engaging in one of these transactions or any other prohibited “self-dealing” can result in a taxable event.

How to Start a Self-Directed IRA

When setting up a self-directed IRA investors have a few options, each with its own caveats. Below are two options:

  • Hire a custodian- Law requires retirement plans to be held with a custodian. A custodian is a bank or other entity authorized by the IRS to administer the account. Administration includes holding the funds, completing reporting requirements and recording transactions.

What to keep in mind: These custodians have different fee structures and levels of expertise to take into consideration. An approved custodian should be listed by the IRS in their Approved Non-bank Trustees and Custodians listings (1). A custodian will invest self-directed IRA funds based on the owner’s discretion. It is up to the investor to do his own due diligence when making investments. Potential processing delays should also be taken into consideration, since these can be costly when dealing with time sensitive real estate investments. Our online platform can reduce processing delays and administrative cost.  

  • Form an LLC- While a custodian can’t be completely avoided, using an LLC for a self-directed IRA can reduce custodial overhead and cost. Under an LLC the self-directed IRA is under the care of the custodian, but managed by the IRA owner. Funds are held in a local checking account accessible to the IRA owner.

What to keep in mind: When the IRA owner wants to make an investment she simply accesses the account as she would a normal checking account. No custodian approval is required for dispersing funds. This results in a more efficient investing process. However, LLCs are sometimes subject to filing taxes and paying an annual franchise tax.

Set up your self-directed IRA today

A self-directed IRA for real estate investing provides flexibility and the benefits of portfolio diversification. Unlike traditional investments, a self-directed IRA allows for a tangible asset to hedge against market uncertainties. Perhaps most appealing is the deferred taxes on real estate investment gains. However, these benefits can be undermined through violation of the IRS’s “self-dealing” rules. Structuring a self-directed IRA under the wrong terms can also lead to transaction delays and costly custodial fees.
We specialize in setting up self-directed IRAs to maximize tax benefits, cost savings and control. Whether you require a self-directed IRA for residential or commercial investments, we can provide you with a nuanced solution. Contact Royal Legal Solutions with your questions or to set up a consultation.

Last Updated: 
March 20, 2018

Scott Royal Smith is an asset protection attorney and long-time real estate investor. He's on a mission to help fellow investors free their time, protect their assets, and create lasting wealth.

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