Self-directed IRAs open up a bundle of investment opportunities that traditional IRAs are restricted from. One of the most popular investments offered is real estate.

With home prices reaching historic highs in major cities across the country, real estate remains a seller’s market.

Using your self-directed IRA to invest in real estate remains a great strategy to preserve the value of your account and generate a profit. The tax preference given to self-directed IRA investments offer a convenient way for homeowners to save money on their investments.

While it sounds easy to dip into your self-directed IRA and place a downpayment on a house, it’s a little more complicated than that. That’s why it’s important to understand the rules governing real estate investments using a self-directed IRA.


Investment Limitations


Self-directed IRAs are heavily regulated to prevent fraud and reduce risk in the market. That’s why the IRS has banned investments that are considered “self-dealing” in nature. This means that you are banned from purchasing or selling your own home using a self-directed IRA.

This stipulation also extends to vacation homes or renting out office space or an apartment to yourself.

You are also not allowed to conduct transactions with certain disqualified people. This includes:

  • Spouses
  • In-laws
  • Parents
  • Relatives
  • Children

Any and all indirect benefits that you or a disqualified person may receive from a real estate investment is banned if owned by your self-directed IRA. This does not include any profits derived from rising home values, but rather gaining the occasional use of a beach home purchased by a self-directed IRA.


Real Estate Profits and Expenses


It’s important to remember that the underlying purpose of the IRA is to save for retirement, not to serve as a short-term trading instrument. This means that any benefits or profit you receive from a real estate investment using your self-directed IRA must go back into the account.

Along the same lines, all expenses related to a property owned by your self-directed IRA must be paid for using the self-directed IRA.



Consult with Horizon Trust

Separating Entities


So why do self-directed IRA investments need to be paid in full using the self-directed IRA? Well, self-directed IRAs are considered a separate entity outside of yourself.

All investments using a self-directed IRA are titled differently: “Equity Trust Company Custodian [for benefit of] (FBO) [Your Name] IRA.” Since your self-directed IRA is separate from yourself, all investments related to the account should not benefit you indirectly to avoid fraud and tax loopholes in the system.


Using Other Financial Instruments


As previously stated, all expenses related to a property paid for by a self-directed IRA must be paid with funds from the account. But this doesn’t disqualify you from seeking out other financial instruments to purchase a property. These could include undivided interest, setting up an LLC, or partnering with others to invest.

When purchasing real estate using a self-directed IRA, you are forced to take out a non-recourse loan for any additional debt. Under these loans, the property is used as collateral against itself, and a lender cannot pursue self-directed IRA funds for any late or outstanding payments if you default. This makes it impossible for your self-directed IRA to retain ownership in the case of a default.


IRA Tax Structures


Tax incentives are also very different for real estate investments using a self-directed IRA. For one, you will not qualify for a 1031 exchange or depreciation because the property is technically not owned by you.

Secondly, if you do pursue a loan to pay for a home, your debt will actually be considered business income. This means that you will be subject to the unrelated business tax income (UBIT) on all real estate investments paid for with a self-directed IRA.