Recent headlines about the astronomical $5 billion of wealth inside PayPal co-founder Peter Thiel’s Roth IRA stunned many.

They wondered how it could build that much wealth inside a retirement account with contribution limits and other restrictions. The answer was that he used a self-directed IRA to purchase shares of PayPal at $0.001 before its IPO.

While a $5 billion IRA portfolio may not be feasible for everyone, you, too, can take advantage of a self-directed IRA to purchase real estate and other unconventional assets that may offer unique growth potential.

Can I Withdraw from My IRA to Invest in Real Estate?

You may be able to withdraw funds from an IRA account to invest in real estate. However, the decision to do so will likely come with certain tax consequences. An IRA – whether traditional or Roth – is known as a nontaxable account, and it offers different tax advantages depending on the type.

With a traditional IRA or 401(k), the contributions and gains in the account are tax-deferred until you take a distribution.

In comparison, distributions from a Roth 401(k) or IRA, including the gains, are non-taxable income. The reason is that you pay tax in the year of the contribution.

Since 401(k)s and IRAs are for retirement purposes, the IRS generally does not allow you to take a distribution before age 59½ without penalty.

Limited exceptions exist for things like financial hardships or medical emergencies, but investing in real estate is not one of them.

In addition to paying any ordinary income taxes owed on an early distribution, the IRS will also impose a 10% penalty. For an investor under the age of 59½, withdrawing IRA funds to invest in real estate may cost more, which is why using a self-directed IRA may be a better option.


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How Do I Set Up a Real Estate IRA?

Traditional IRA investments include assets like stocks, bonds, mutual funds, ETFs, and other cash investments. However, the IRS allows what is known as a self-directed IRA, enabling you to invest in alternative assets like real estate.

The IRA is self-directed because it is independent of brokerages and financial firms that ordinarily manage your account decisions (i.e., what to invest in). In other words, you make the investment decisions with a self-directed IRA.

Establishing a self-directed IRA for real estate investments requires finding a certified IRA custodian – like Horizon Trust – to assist with the account’s record-keeping and tax reporting requirements. After choosing an IRA custodian, setting up the account is not difficult.

You choose the type of IRA you want (i.e., traditional or Roth), complete the required application form, and contribute funds. You can contribute funds to a real estate IRA in a couple of methods:

  • Rollover or transfer funds from another 401(k) or IRA (be aware of potential tax issues when transferring funds from a traditional IRA to a Roth IRA)
  • Contribute earned income (the contribution limit for 2021 and 2022 is $6,000)

3 Tips for Using an IRA to Invest in Real Estate

Now that you have a general sense of how and why you might set up a self-directed IRA for real estate investments, here are 3 tips for additional education on the subject.

1. Understand the Restrictions and Rules

Using an IRA to purchase investment real estate can provide tax-deferred benefits. However, those benefits come at the cost of complying with various regulations.

One of the most important rules that real estate IRA owners must understand is that the IRA owns the property.

This means legal documents such as deeds and purchase agreements must be in the name of the IRA custodian (e.g., “Horizon Trust Company, custodian for [insert name your name] IRA”).

Since the IRA owns the real estate, the IRS further restricts you and other disqualified persons in how you use and maintain the property. Disqualified persons generally refer to your spouse, children, children’s spouses, grandchildren, and other family members.

Some examples of these rules include:

  • You and disqualified persons cannot already own or use a property you plan to purchase with IRA funds
  • You cannot live in or lease the property to yourself or your family
  • Your business can’t lease the property
  • You must use IRA funds to cover expenses related to the property (e.g., maintenance, property taxes, HOAs, mortgage, etc.)
  • Other self-dealings

We recommend self-directed IRA owners work with their attorneys and accountants regarding questions about the tax consequences and other rules related to IRA real estate investments.

2. Consider Your IRA’s Options for Purchasing the Real Estate

Usually, you must purchase real estate for an IRA with funds from the account (i.e., prior contributions, funds rolled over from another IRA, or any income and gains).

Purchasing real estate outright might not be possible for some self-directed IRAs because of insufficient funds. However, alternatives exist that allow IRA real estate investors to stretch their account’s capital.

Obtain a Mortgage 

Your IRA may qualify for a mortgage to finance the cost of purchasing an income-producing property. Like any mortgage, the lender will take a security interest in the property the IRA purchases with loan proceeds if the IRA defaults on the loan. As mentioned above, IRA funds must cover the cost of repaying the loan.

Acquire an Equity Interest in a Business That Holds Real Estate

Another option for IRA owners to invest in real estate is to acquire an equity interest of a business that owns real estate. This could be an entity such as an LLC, a partnership, or a trust.

IRA owners should be mindful of avoiding prohibited transactions when it comes to acquiring business interests.

For example, your IRA can’t invest funds in an entity where a disqualified person owns more than 50%. Additionally, the IRS prohibits your IRA from investing in an entity that you own 10% of or an entity where you are an officer, director, or a highly compensated employee.

3. Explore Various Types of Real Estate Investments 

A real estate investment through an IRA can take different forms. Some types may be preferable based on your investment knowledge and skillset.

We often suggest working with real estate professionals to help you identify suitable investments for your risk level and budget. Some options may include:

  • Rental property
  • House flips
  • Deeds of trusts and mortgage (i.e., buying notes collateralized with property)
  • Tax deeds (liens for delinquent taxes on real estate)

Acquiring different types of real estate investments for an IRA may help establish a diverse and resilient real estate portfolio.

After a Strong 2023, Will Investing in Real Estate Still Be a Good Idea in 2024?

Real estate investments have traditionally provided positive returns in the long term. Whether a real estate investment is a good idea in 2022 will depend on several factors. This may include the market conditions of a prospective property, the investment timeline, your finances, and your other asset allocations.

In any case, using a self-directed IRA for real estate investments in 2022 may offer diversification advantages for those looking to rebalance their portfolio or find additional growth.

Book an appointment with Horizon Trust today to start investing in real estate through an IRA.