A self-directed IRA (SIDRA) allows you to save money for retirement on a tax-advantaged basis while enjoying access to a broader range of investments. Opening a self-directed IRA for real estate investing is an opportunity to diversify your portfolio with an alternative asset class while potentially generating higher returns.
Using a self-directed IRA to invest in real estate offers the added benefit of either tax-deferred growth or tax-free withdrawals in retirement, depending on whether it’s a traditional or Roth IRA. Before making a move, however, it’s important to know how they work. The IRS imposes self-directed IRA real estate rules that investors must follow to reap tax benefits.
What Is a Self-Directed IRA?
Individual Retirement Accounts (IRAs) allow you to set aside money for retirement with built-in tax benefits. These retirement accounts come in two basic forms: traditional and Roth.
Traditional IRAs allow for tax-deductible contributions, while Roth IRAs let you make qualified distributions tax-free.
When you open a traditional or Roth IRA at a brokerage you might be able to invest in mutual funds, exchange-traded funds, or bonds. A self-directed IRA allows you to fund your retirement goals with alternative investments — including real estate.
You can do the same thing with a self-directed 401(k).
Self-directed IRAs have the same contribution limits as other IRAs. For 2024, you can contribute up to:
• $7,000 if you’re under 50 years of age
• $8,000 if you’re 50 or older
Contributions and withdrawals are subject to the same tax treatment as other traditional or Roth IRAs. The biggest difference between a self-directed IRA and other IRAs is that while a custodian holds your account, you manage your investments directly.
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💡 Quick Tip: Want to lower your taxable income? Start saving for retirement with an IRA account. With a traditional IRA, the money you save each year is tax deductible (and you don’t owe any taxes until you withdraw the funds, usually in retirement).
How Self-Directed IRAs for Real Estate Investing Work
Using a self-directed IRA to invest in real estate allows investors to invest in various funds or securities that, themselves, invest in property or real estate. Those securities may be real estate investment trusts (REITs), mutual funds, or ETFs focused. Investors with self-directed IRAs can, then, direct retirement account funds toward those securities.
Other types of real estate investments can include single-family homes, multi-family homes, apartment buildings, or commercial properties — actual, physical property. For investors who do want to buy actual property using an IRA, the process generally involves buying the property with cash (which may require them to liquidate other investments first), and then taking ownership, which would all transact through the IRA itself. It’s not necessarily easy and can be complicated, but that’s the gist of it.
With that in mind, the types of investments you can make within an IRA will depend on your goals.
For instance, if you’re interested in generating cash flow you might choose to purchase one or more rental properties using a self-directed IRA for real estate. If earning interest or dividends is the goal, then you might lean toward mortgage notes and REIT investing instead.
The most important thing to know is that if you use a retirement account to invest in real estate, there are some specific rules you need to know. For instance, the IRS says that you cannot:
• Use your retirement account to purchase property you already own.
• Use your retirement account to purchase property owned by anyone who is your spouse, family member, beneficiary, or fiduciary.
• Purchase vacation homes or office space for yourself using retirement account funds.
• Do work, including repairs or improvements, on properties you buy with your retirement account yourself.
• Pay property expenses, such as maintenance or property management fees, from personal funds; you must use your self-directed IRA to do so.
• Pocket any rental income, dividends, or interest generated by your property investments; all income must go to the IRA.
Violating any of these rules could cause you to lose your tax-advantaged status. Talking to a financial advisor can help you make sense of the rules.
Pros and Cons of Real Estate Investing Through an IRA
Using a self-directed IRA for real estate investing can be appealing if you’re ready to do more with your portfolio. Real estate offers diversification benefits as well as possible inflationary protection, as well as the potential for consistent passive income.
However, it’s important to weigh the potential downsides that go along with using a self-directed IRA to buy real estate.
| Pros | Cons |
|---|---|
|
• Self-directed IRAs for real estate allow you to diversify outside the confines of traditional stocks, bonds, and mutual funds. • You can establish a self-directed IRA as a traditional or Roth account, depending on the type of tax benefits you prefer. • Real estate returns can surpass those of stocks or bonds and earnings can grow tax-deferred or be withdrawn tax-free in retirement, in some cases. • A self-directed IRA allows you to choose which investments to make, based on your risk tolerance, goals, and timeline. |
• The responsibility for due diligence falls on your shoulders, which could put you at risk of making an ill-informed investment. • Failing to observe self-directed IRA rules could cost you any tax benefits you would otherwise enjoy with an IRA. • The real estate market can be unpredictable and investment returns are not guaranteed — they’re higher-risk investments, typically. Early withdrawals may be subject to taxes and penalties, and there may be higher associated fees. • Self-directed IRAs used for real estate investing are often a target of fraudulent activity, which could cause you to lose money on investments. |
Using a self-directed IRA for real estate or any type of alternative investment may involve more risk because you’re in control of choosing and managing investments. For that reason, this type of account is better suited for experienced investors who are knowledgeable about investment properties, rather than beginners.
Real Estate IRAs vs Self-directed IRAs For Real Estate Investing
A real estate IRA is another way of referring to a self-directed IRA that’s used for real estate investment. The terms may be used interchangeably and they both serve the same purpose when describing what the IRA is used for.
Again, the main difference is how investments are selected and managed. When you open a traditional or Roth IRA at a brokerage, the custodian decides which range of investments to offer. With a self-directed IRA, you decide what to invest in, whether that means investing in real estate or a different type of alternative investment.
💡 Quick Tip: Did you know that opening a brokerage account typically doesn’t come with any setup costs? Often, the only requirement to open a brokerage account — aside from providing personal details — is making an initial deposit.
Opening an IRA With SoFi
Opening a self-directed IRA is an option for many people, and the sooner you start saving for retirement, the more time your money has to grow. And, as discussed, a self-directed IRA allows you to save money for retirement on a tax-advantaged basis while enjoying access to a broader range of investments, including real estate.
Once again, using a self-directed IRA to invest in real estate offers the added benefit of tax-deferred growth and tax-free withdrawals in retirement. There are pros and cons, and rules to abide by, but these types of accounts are another option for investors.
Ready to invest for your retirement? It’s easy to get started when you open a traditional or Roth IRA with SoFi. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).
FAQ
Can you use a self-directed IRA for real estate?
You can use a self-directed IRA to invest in real estate-related or -focused securities and other types of alternative investments. Before opening a self-directed IRA to invest in real estate, it’s important to shop around to find the right custodian. It’s also wise to familiarize yourself with the IRS self-directed IRA real estate rules.
What are the disadvantages of holding real estate in an IRA?
The primary disadvantage of holding real estate in an IRA is that there are numerous rules you’ll need to be aware of to avoid losing your tax-advantaged status. Aside from that, real estate is less liquid than other assets which could make it difficult to exit an investment if you’d like to remove it from your IRA portfolio.
What are you not allowed to put into a self-directed IRA?
The IRS doesn’t allow you to hold collectibles in a self-directed IRA. Things you would not be able to hold in a self-directed IRA include fine art, antiques, certain precious metals, fine wines, or other types of alcohol, gems, and coins.
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