How to invest in real estate with a self-directed IRA: Case study

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Ever wish you could invest in real estate tax-free through your retirement accounts?

You can.

And it’s not hard, either. Look no further than Martha’s story retiring to Europe with a single investment property. She owned that rental property under a self-directed IRA (SDIRA).

If that story focused on the specifics of her rental property investment, this one drills into the details of how to invest in real estate using a self-directed IRA. And not just with rental properties, but also with passive real estate investments.

Here’s to avoiding taxes — legally.

Key Takeaways:

    • You can invest in almost any type of real estate by opening a self-directed IRA with a custodian.
    • It’s much easier to invest in passive real estate investments (such as real estate syndications or crowdfunding investments) with an SDIRA than buying properties directly.
    •  If you finance a rental property bought under an SDIRA, only part of the property qualifies for tax benefits.

5 Ways to Invest in Real Estate with an SDIRA

Sure, you could invest in real estate investment trusts (REITs) in a standard brokerage IRA. But REITs are correlated with stocks too closely to offer much diversification benefit.

To expand their options, some investors open a self-directed IRA to invest in real estate. But some of those options prove easier than others.

Starting from easiest to most difficult, consider these options to invest in real estate with an SDIRA.

Real Estate Crowdfunding: Fractional Shares in Rentals

Real estate crowdfunding” covers many types of investments. The simplest to understand is fractional ownership in rental properties.

You buy a small percentage of the property, becoming one of many owners of the LLC that owns that property. You collect your share of the rental income, and when the property sells, you get your share of the profits.

The oldest and largest platform for fractional ownership in rentals is Arrived. It allows non-accredited investors, and features a low minimum investment of $100. The downside: once you buy shares in a property, you’re stuck holding them until the property sells in five to seven years.

Two other platforms have since come along that offer a secondary market for selling shares. Check out Ark7 and Lofty as newer platforms with more liquidity than Arrived.

You can invest in real estate on any of these with a self-directed IRA.

Real Estate Crowdfunding: Equity Funds

Rather than buying fractional ownership in a single property, you can instead invest in a fund that owns many properties. Some meet the legal definition of a REIT, others don’t.

On the plus side, you get broader diversification, which helps spread your risk. You also get less fine-tuned control over what you invest in.

With an SDIRA custodial account, you can buy shares of private REITs such as Fundrise and Streitwise (I own shares in both, for full disclosure). Both allow non-accredited investors to participate.

Real Estate Crowdfunding: Secured Debt

You can also invest in loans secured by real property. Unlike equity investments — where you own a percentage of the property — these typically pay a fixed interest rate.

I personally like GroundFloor for this: you can invest as little as $10 in each loan. You get to pick and choose which loans you want to fund, based on risk grading, interest, and the property and borrower details. Most of these are short-term investments, under a year, so it doesn’t lock up your funds indefinitely.

Groundfloor also offers fixed-interest notes, where you lend the company money directly. Other examples of note investments include EquityMultiple’s Alpine Notes and Norada Real Estate’s notes.

Private Equity Real Estate Syndications & Funds

Coming full circle back to fractional ownership, you can invest in private equity real estate with your SDIRA.

In a real estate syndication, you own fractional shares in a commercial property such as an apartment complex or mobile home park. Alternatively, you can also buy shares in a private equity real estate fund that owns many properties, or debts secured by real estate.

Most real estate syndications and funds target high returns, in the 15-30% range. You get all the benefits of real estate ownership — cash flow, appreciation, and tax advantages — with none of the headaches.

So what’s the catch?

Like most real estate crowdfunding platforms, private equity real estate is usually a long-term commitment of three to seven years, with no liquidity. But the greater catch is the high minimum investment, typically $50,000 – $100,000.

Unless, that is, you invest through a real estate investment club. Like, say, our Co-Investing Club, which lets each member invest $5,000 in any given deal. And yes, members can invest with SDIRA funds.

Just sayin’.

Direct Ownership: Rental Properties

Investing in rental properties in your self-directed IRA involves some extra complications, compared to real estate crowdfunding investments. But real estate investors also get more control over direct property ownership and management.

The greatest challenge with buying rental properties with your self-directed IRA is the high cost of entry. As of 2024, you can only contribute $6,500 per year in an IRA ($7,500 for 50+ taxpayers). Even if you borrow a rental property mortgage, it would still take you years to contribute enough to cover a 20% down payment and closing costs.

And that says nothing of the complications of unrelated business income tax (UBIT), and having to pay taxes on the financed portion of your property. More on that shortly.

Because investing in rental properties in an SDIRA is so much more complicated than the passive investments outlined above, we’ll illustrate it with a case study.

Case Study: Buying a Rental Property with an IRA

Martha and her husband Terry (who asked that we not share their last name) decided to use the majority of their retirement account funds to buy a rental property.

“The 2008 crash was a wake-up call for us. Leaving our retirement savings in the stock market and hoping for the best was too risky. Somebody dreamed up derivatives and rode that train ‘til it crashed and brought down a huge portion of the economy with it. Our retirement plan took a hit like everyone else. And we were helpless fools in the whole debacle.

“Now real estate was something tangible; something we understood much better than the financial markets. The returns are based on the local market driven demand for housing.”

Martha and Terry decided it was time to diversify. They followed these steps to buy a rental property with an IRA.

Step 1: Find a Custodian

With a self-directed IRA, you need a custodian or trust company to administer it for you and comply with IRS rules.

“The first thing we did was find a trust company that would agree to handle it. The trust company ‘manages’ the IRAs for us. We set up IRAs with them; they then invested where we told them to invest.

“It’s important to understand the relationship with the trust company – they make their money by charging a percent of the value of the trust. And you need to be careful what you are signing up for! It’s a long-term relationship with that company and a serious financial commitment.”

I asked Martha about her tips for other real estate investors thinking about a self-directed IRA, and which trust company she used. “I guess the most valuable tip is to shop for a trust company before you start looking at properties or making investment decisions. The choice of a custodian is important and should not be part of the rush or timeline when buying a property.

“We are very happy with the service that our trust company gives us (Peak Trust Company). Their fees seem reasonable.”

Try Millennium Trust Company as a reputable custodian for your self-directed IRA, who’s familiar with real estate investments. They work closely with Fundrise as SDIRA partners.

With us so far? You sign up with a trust company, they create the self-directed IRA for you, then you rollover some or all of the money from your existing IRA, 401(k), or other tax-deferred retirement account to your new self-directed IRA.

If you’ve ever changed jobs and had to rollover your 401(k) funds from your previous employer to a new one, or to an IRA, you know how the process goes. It’s relatively easy; they give you a form to fill out and you transfer the funds.

Step 2: Setting Up a Company to Invest Through

Own your rental properties under an LLC? It’s basically that simple.

“We set up an LLC for the purpose of owning and leasing real estate. My husband’s self-directed IRA owns a percentage of the LLC, and my self-directed IRA owns a percentage of the LLC.

“Setting up the LLC is pretty straightforward. We had a law firm help fine tune the language of the operating agreement.” It’s worth noting that many people form LLCs on their own, depending on their level of comfort.

You file Articles of Organization with your state’s business licensing administration. It’s not “rocket surgery,” as my ex-girlfriend used to say.

“Then we set up a bank account, got a tax ID number and we were in business! The trust company can then cut the checks to buy the property.”

To recap: you open an account with a trust company to create a self-directed IRA, and transfer money to it. Then you create an LLC to buy the rental property under, so that your self-directed IRA has something to invest in!

Step 3: Financing a Rental Property in a Self-Directed IRA

Martha and Terry Robinson did not finance the rental property they bought in their self-directed IRA; they paid cash.

But that doesn’t mean you can’t use financing to buy rental properties under your self-directed IRA.

Borrowing money to buy real estate in your self-directed IRA is nearly identical to borrowing otherwise. You secure a loan, either from a mortgage that does landlord loans or from a private lender (whether a company or individuals, such as friends or family).

But if you do finance your rental properties in a self-directed IRA, there are two important points you need to understand:

First, to finance investment properties bought under a self-directed IRA, the loan must be a “non-recourse” loan. That means the borrower is not personally liable for the debt: the lender can only go after the collateral — the rental property — in the event of a default.

Not every lender will agree to that. Definitely a question to ask lenders early in the process, if you’re considering buying real estate using a self-directed IRA!

The second point you need to know about financing real estate in a self-directed IRA is that the property’s revenue is only partially tax-sheltered. It gets complicated quickly, but the short version is that only the “non-financed portion” of the property gets the tax benefits.

Financing Example in an SDIRA

To use a simple example, say you buy a rental property under your self-directed IRA for $100,000, and you finance half of the purchase ($50,000). The IRS only considers the half you paid cash for as the tax-free portion. So, half of your cash flow would be tax-free, and you would pay taxes normally on the other half.

Talk to your trust company about the details of how this exactly works from a year-to-year tax perspective. It’s above my pay grade.

Whether you borrow money or stick to your own cash in your self-directed IRA to buy the rental property, your LLC now owns the rental property. Congratulations!

How Rental Cash Flow Works in a Self-Directed IRA

What happens to the cash flow from the rental property?

The short version: The tax-free rental income must stay in your SDIRA until you reach at least 59 ½, otherwise it counts as an early distribution and you must pay both taxes and penalties on it.

I’ll let Martha explain in her own words, how their cash flow works in their LLC and self-directed IRA:

“The money flows like this: We’ve hired a property management company to manage the apartments, including leasing, maintenance, collecting rents, paying bills, etc. Once per month, the property management company collects the rents and deposits the net proceeds into the LLC bank account. We control that account.

“Then once per month, the LLC pays a dividend to Terry’s IRA and my IRA at the trust company.”

Cash flow from the investment property goes to the self-directed IRA. Since you control what the self-directed IRA invests in (hence the name), you could use it to pay down debt on the rental property (if you have any), or invest in anything else: equities, private notes, even more rental properties!

Now, if you’re a young person not yet retired, that would be the end of the discussion. But Martha and her husband Terry have now retired, and withdraw money to live on from their self-directed IRA.

“The trust company then turns around and sends us IRA disbursements once per month. The trust company does the tax withholding for the IRA disbursements and issues the 1099’s at the end of the year.”

Separation of Personal & LLC Funds

Strasbourg, France, where Martha and Terry have parked their houseboat for the last few months.

“One thing we are very cognizant of is that the LLC account, funds, cash flow, etc. must always be completely separate from anything else we are doing. Funds must never, ever, ever be used by us directly or co-mingled.”

The IRS doesn’t have a sense of humor about commingling tax-protected funds in a self-directed IRA with personal funds. They will rain fire and brimstone down upon thee if you do it.

“We manage our LLC and rental property for the benefit of our IRAs. Not for our personal benefit.”

It may seem like an odd distinction, but it’s one worth making.

“We grossed $108,000 last year, and after paying all the expenses of taxes, management, maintenance, utilities, etc. we netted $63,000.”

That money went into their LLC bank account, then to their self-directed IRA, then was disbursed back out to them as retirement funds to live on. Easy peasy.

Should I Open a Self-Directed IRA?

Should you invest in a rental property using a self-directed IRA?


First, it’s a bit more complicated than just setting up a standard IRA with your investment banker and investing in index fund ETFs. If the words “trust company” make your eyes cross, maybe you’re better off investing in real estate separately and keeping a conventional IRA for now.

To be frank, that’s what I do. Real estate comes with plenty of inherent tax benefits, from depreciation to rental property tax deductions. Besides, I invest in stocks in addition to real estate, so why not hold some of those stocks in my IRA?

Another issue is that it can be tough to find vendors who are comfortable working with a self-directed IRA. “One of the biggest challenges is that not many folks do this, so getting accountants, contractors, property managers, banks, etc. up to speed is sometimes a lengthy process.”

Then there’s the commingling issue. Granted, It’s not like the money is going to wander from your LLC bank account to your personal checking account on its own! But that doesn’t mean everyone has the discipline to keep the money separate.

If you struggle with budgeting and controlling your spending, it can be tempting to pull money from anywhere it seems available. That spells trouble for commingling funds.

For all that, a self-directed IRA is an incredibly flexible way to invest in real estate for retirement. You get the full tax benefits of an IRA, but the ability to invest in rental properties, private notes, or almost anything else you choose. Martha has been thrilled with it.

“We couldn’t be happier with how it’s performed. Even if the real estate market goes into another slump, we are not worried. We do not have to service a loan, we can just lower rents. Oh well.”♦

Have you ever considered investing in real estate with a self-directed IRA? What’s held you back from SDIRA real estate investing?

This article originally appeared on SparkRental and was syndicated by MediaFeed.

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