How to Use a Self-Directed IRA for Real Estate?

By Bill Lyons | Published on February 5, 2024

Offering you the best of both worlds, a self-directed IRA for real estate, or SDIRA, offers the preferential tax treatment of an IRA with the flexibility and autonomy to invest in real estate opportunities. Whether you want a fix-and-flip property, a long-term rental opportunity, or a short-term vacation rental solution, a self-directed IRA for real estate can make it possible. 

Continue reading to learn what a self-directed IRA is for real estate investing and why you should consider this vehicle. 

What Is a Self-Directed IRA for Real Estate?

A self-directed IRA (SDIRA) for real estate is an individual retirement account that you can direct to hold real estate as an investment. Using a self-directed IRA for real estate can open the door to several types of real estate investments, including: 

1. Multi-family and single-family homes
2. Rental properties
3. Commercial properties
4. Mortgage notes
5. International properties
6. Raw land 
7. Mobile homes
8. Other property alternative investments

You can also invest in real estate by issuing mortgage notes or through real estate investment trusts (REITs). Using a self-directed IRA for real estate is similar to a typical real estate purchase. While the property would be in your name in a typical purchase, the property would be owned by a self-directed IRA. Any income or expenses from the investment are processed through the IRA. 

As long as you conduct transactions within your self-directed IRA, you are not required to pay taxes on the income generated from the property. For instance, any rental income the property generates will go directly into the IRA for preferential tax treatment based on the type of account. 

Benefits of Self-Directed IRAs for Real Estate  

Utilizing a self-directed IRA for real estate offers you an unrivaled level of flexibility and control over your future. Instead of being relegated to invest in a pre-selected menu of investments, a self-directed IRA allows you to go beyond typical bonds, stocks, and funds. 

Benefits of self-directed IRAs include potentially higher returns, diversification and risk mitigation, tax advantages, and more. 

Potential for Higher Returns

Investing in real estate with a self-directed IRA can allow you to achieve greater returns. The potential for higher returns can lift the overall performance of your portfolio and help you achieve a better retirement outcome. 

Diversification and Risk Mitigation

Stock prices are much more volatile than real estate. Utilizing a self-directed IRA for real estate can increase your level of diversification and mitigate risk, even in times of real estate inflation. 

Tax Advantages for Self-Directed IRA for Real Estate

Self-directed IRAs offer the same tax benefits as a regular IRA. With a self-directed IRA, you will enjoy preferential tax treatment. However, the type of SDIRA can determine the timing of these tax advantages. Because of this, it’s critical to select the best self-directed IRA for real estate based on your needs and financial situation. 

Risks of Self-Directed IRAs for Real Estate

There are always two sides to every coin. Just as there are benefits to using an SDIRA for real estate, there are risks. 

• Poor location: As with any investment, you want it to mature and grow. However, if you choose a property in the wrong location, you could lose a substantial portion of your principal investment. 
• Negative cash flow: There are many tax benefits of real estate investing. But real estate held in an IRA is not eligible for the same deductions. If your property has negative cash flow, you will not benefit from the loss. 
• High vacancies: If you use the property to generate rental income, one of the main risks is the inability to find tenants. Savvy real estate investors conduct extensive research and strategically select locations likely to remain occupied, such as near colleges or areas with high rental demand. 
• Problem tenants: A good tenant can make managing the property easy, but the wrong tenant can be a nightmare. If you’re considering using a self-directed IRA for real estate rental revenue, use proven screening techniques to reduce the likelihood of a bad tenant. 

Steps to Use a Self-Directed IRA for Real Estate

Using an SDIRA for real estate is similar to a typical real estate purchase. However, there are differences and nuances you should understand. The following steps outline how to successfully use a self-directed IRA for real estate investing: 

Set up a Self-Directed IRA

The first step in using a self-directed IRA for real estate investing is to establish an account. You will need to select the type of self-directed account you will use, such as a traditional IRA, Roth IRA, or individual 401(k)

1. Traditional SDIRAs are funded with pre-tax dollars, which means you can deduct contributions from your taxes in the year you make them. Your earnings will grow tax-deferred, and any retirement distributions will be taxed like regular income. The Traditional IRA approach is usually the best option for investors who expect their tax rate will be lower in retirement when they distribute their assets. 
2. Roth SDIRAs only use after-tax money, so when you withdraw the money in retirement, you will already have paid taxes on the funds. 
3. Individual 401(k)s are designed for small business owners who do not have employees. These accounts are funded with pre-tax dollars, and the distributions are treated like a traditional IRA. 

Fund the Self-Directed IRA

Once you have selected the best type of self-directed IRA for real estate, you must fund the account. To do so, you can:

• Transfer funds from the same type of account, e.g., from a Roth IRA to a self-directed Roth IRA. The accounts must be the same type due to each IRA’s different type of preferential tax treatment. 
• Rollover funds from a different type of account.
• Annually contribute to the SDIRA for real estate based on the IRS contribution limits.  

Identify and Research Real Estate Investments 

Finding the right property for your SDIRA is paramount. But before you decide on a property, you must review IRS guidelines to ensure compliance with rules and regulations. 

The property you purchase, its intended use, and its inhabitants must align with all IRS rules. Understanding these rules can help you protect your retirement savings by maintaining the tax-advantaged status of the account. 

Make the investment

Now that you’ve found a suitable property or investment, you must determine how to pay for it. If you have the cash in the self-directed IRA, you may opt to pay in cash. Many self-directed IRA investors choose to finance the purchase of the property. 

However, you can’t use a conventional mortgage to purchase a property through your self-directed IRA. Instead, you must use a non-recourse loan to purchase the property in the name of the IRA. After the escrow is closed, you can lease or rent the property. Then, the self-directed IRA must receive all income and pay all expenses, including maintenance and closing costs. 

Utilize Self-Directed IRAs for Real Estate Investing

Utilizing a self-directed IRA offers you the autonomy to capitalize on alternative investments, including real estate. While established IRA and 401(k) balances may support a real estate purchase, many investors finance the purchase with non-recourse mortgages. 

At Griffin Funding, we are the leading provider of non-qualifying mortgage options. Our seasoned mortgage specialists will work closely with you to help you find the perfect mortgage solution for your unique needs. 

Contact Griffin FUnding today to learn more about our non-qualifying mortgage options. 

Frequently Asked Questions

How does a self-directed IRA differ from a traditional IRA or Roth IRA?

A self-directed IRA offers much greater autonomy over the type of investments you can make with the account. The main difference between an IRA and a self-directed IRA is the type of investments the account can hold. 

Generally, regular IRAs are limited to securities like bonds, stocks, CDs, mutual funds, and exchange-traded funds. A self-directed IRA allows a broader array of investments called alternative assets. Because of this, the SDIRA requires more due diligence and initiative but can yield greater returns. 

What types of real estate can you invest in using a self-directed IRA? 

Using a self-directed IRA for real estate can open the door to several types of property investment options, including:

1. Multi-family and single-family homes
2. Rental Properties
3. Commercial properties
4. Mortgage notes
5. International properties
6. Raw Land 
7. Mobile Homes
8. Other property alternative investments

Can you purchase real estate with a self-directed IRA?

Yes, you can purchase real estate with a self-directed IRA. However, any real estate you purchase must be for investment purposes. You and your family are not allowed to use it. 

Bill Lyons

Bill Lyons is the Founder, CEO & President of Griffin Funding. Founded in 2013, Griffin Funding is a national boutique mortgage lender focusing on delivering 5-star service to its clients. Mr. Lyons has 22 years of experience in the mortgage business. Lyons is seen as an industry leader and expert in real estate finance. Lyons has been featured in Forbes, Inc., Wall Street Journal, HousingWire, and more. As a member of the Mortgage Bankers Association, Lyons is able to keep up with important changes in the industry to deliver the most value to Griffin's clients. Under Lyons' leadership, Griffin Funding has made the Inc. 5000 fastest-growing companies list five times in its 10 years in business.