Piggy moneybox with dollar cash. Retirement.

Diversify Your Retirement Account with a Self-Directed IRA

Did you know that you can use your retirement funds to invest in real estate? As someone saving for retirement, you have the ability to choose investments other than the traditional offerings of stocks, bonds, mutual funds, etc. within your Individual Retirement Account (IRA). Self-Directed IRAs (or “SDIRAs” as they are known) is a different type of retirement account that allows you to invest in alternative assets – including real estate, syndications, hedge funds, private equity investments and more.

If you’re wondering why you’ve never heard of this option before, the answer is simple: Wall Street. The big guns over on Wall Street want you to keep funneling your retirement money through providers who exclusively provide investment options in the form of 401(k)s, mutual funds and other restricted options that keep your money in the stock market. However, investing in real estate with an SDIRA can be a great way to diversify your retirement account.

Advantages of Investing through a Self-Directed IRA

  • Investment Control: As the account owner, you are the sole decision maker when it comes to investing your IRA funds. You alone get to determine when, where and how to invest.
  • Diversification: An SDIRA gives you the option to invest beyond the traditional market of stocks, bonds and mutual funds. You have the option to invest in alternatives such as real estate, meaning you can own actual property and not be held to the limitations of the stock market.
  • Tax Benefits: The SDIRA acts as a tax shelter, meaning the profits you generate using the IRA returns to the IRA completely sheltered from taxes. This includes all rental income and sale proceeds. The SDIRA will protect your real estate deals from capital gains taxes, depreciation or capture taxes, and more.
  • Secure Assets: Under federal bankruptcy law, SDIRAs are afforded protection to ensure assets are secure.
  • Ongoing Wealth Accumulation: Since there is no limit to the amount of profit you can generate inside your retirement account, the tax sheltered nature of an IRA allows you to keep more money within the account. Which also gives you more cash available for your next real estate deal. Select SDIRAs will allow assets to be passed to beneficiaries after death with little or no tax, which allows you to stretch the wealth over generations.

How to Set Up a Self-Directed IRA and Purchase Real Estate

A key difference when converting your retirement funds to an SDIRA is the requirement of a trustee or custodian of the account. There are many custodians to choose from and all offer different types of SDIRA set-ups with their own set of rules and regulations. It’s best to do your own due diligence before taking this step.

Use this list of Self-Directed IRA Custodians and Administrators to start your research.

Once you’ve found a custodian you can trust, the first step is opening up a new Self-Directed IRA. In order to fund your SDIRA, you can roll over an existing account, make a personal contribution or roll over from an old employer plan. Traditional and Roth IRAs can be converted into SDIRAs, but 401(k) plans are a bit different.

If you are still employed by the company that sponsors your 401(k), you will not be able to move the money into your SDIRA. Only if you have an old 401(k) from a former employer can you roll that over into your new SDIRA. It is common to see people rolling over many different accounts such as an old 401(k), pension, 403(b), or a Thrift Savings Plan (TSP).

Once you have a fully funded SDIRA, you’re ready to start investing. All you need to do is identify the property you’d like to purchase with your IRA, contact your custodian, and they will walk you through the purchase process.

Real estate can be purchased with an SDIRA in many ways:

  • Cash Purchase: If the IRA has enough money in it to purchase 100% of the property.
  • Partnering Funds: If you don’t have enough funds to cover 100% of the real estate purchase, your IRA can partner with anyone to complete the purchase and share profits and responsibilities of the investment. Acceptable fund partners include your personal money, a friend, an associate, a family member or even partnering with another IRA account to co-own. This co-ownership is referred to as “tenancy in common.” Each partner pays their share of the expenses and collects their share of income associated with the property based on the purchase partnership agreement.
  • Borrowing Money: The only type of debt an IRA can take out is a Non-Recourse Loan. With a NRL, the IRA is the borrower and the loan is secured by the property being purchased within the IRA account. The IRA owner cannot personally guarantee the loan as IRS rules prohibit using individual credit for the benefit of your IRA.
    • There are a few possible tax implications with this option: UBIT (Unrelated Business Income Tax), or UDFI (Unrelated Debt Finance Income Tax), so be sure to consult a tax attorney before borrowing with your SDIRA.

Rules to Keep in Mind When Purchasing Real Estate with Your Retirement Plan

There are a few rules you absolutely follow when purchasing real estate with your SDIRA in order to stay within the regulations of the IRS.

  • Proper Titling: As the IRA is the purchaser, the real estate will be titled in the name of the IRA. The purchase must be titled correctly to show the real estate investment as an asset within the IRA account instead of your personal property, which would be taxable.
  • No Personal Use of Property: Real estate owned within an IRA must be for investment purposes only, meaning there is absolutely no personal use of the property.
  • No Family Deals: You cannot rent to, buy from, or sell to any disqualified parties, which include all lineal ascendants and descendants.
  • All income and expenses must go through the IRA:
    • Since the IRA owns the real estate, all income must return to the IRA and all expenses, property taxes for example, must be paid out of cash in the IRA account.
    • If partnering with another party to purchase your IRA property, all income and expenses would be split according to the percentage ownership.

While stocks and bonds provide a solid long-term strategy for most retirement portfolios, incorporating alternative investments into the mix provides a means to diversify your retirement portfolio. Purchasing real estate with your retirement funds through the use of a Self-Directed IRA is an easy way to invest in secure assets that can provide long-term wealth accumulation to future generations, while still benefiting from the tax advantages offered by retirement savings.