Each week, I encounter the same concern from entrepreneurs and investors: “I was informed that buying real estate with my IRA isn’t possible.” This is misleading. What they actually heard was that their broker wouldn’t assist them with this. There’s a critical difference.
The IRS has always permitted retirement accounts to invest in real estate. The real limit comes not from the tax regulations, but from Wall Street itself. Let’s explore how this operates, why individuals choose this route, and the guidelines you need to follow to avoid tax implications and penalties.
Indeed, Your Retirement Account Can Hold Real Estate Your IRA, Roth IRA, 401(k), or HSA isn’t restricted to just stocks, bonds, ETFs, or mutual funds. The limitations stem from brokerage firms, not the IRS. Brokerages profit from selling Wall Street products, and they don’t earn commissions when you purchase rental properties, which is why they often don't provide that option.
By opting for a self-directed retirement account, you can change this dynamic. You’re not violating any rules or exploiting loopholes; instead, you’re selecting investment options your current custodian may not facilitate. When someone claims you can’t do this, it typically means they can't assist you with it.
Reasons Investors Choose Real Estate in Retirement Accounts The reasoning is straightforward: better returns and more control. Many investors prefer not to limit their retirement growth to low single-digit returns, especially if they have a solid understanding of real estate. Well-managed long-term rentals, short-term rentals, commercial properties, raw land, and development opportunities often yield superior returns.
For those already involved in real estate, it frequently makes sense to let your retirement account pursue similar investments. This doesn’t imply abandoning Wall Street; rather, it suggests finding a balance. True wealth emerges from diversification rather than concentrating all assets in one area.
Determine the Type of Real Estate You Prefer Before reallocating any funds, it’s crucial to be deliberate. Self-directing offers freedom, but without a strategy, that freedom can lead to poor decisions. Identify the kind of real estate you comprehend well—be it long-term rentals, short-term rentals, commercial properties, storage units, farmland, or raw land.
There isn’t a “best” asset for a retirement account; the most suitable investment is one you thoroughly understand and can manage efficiently.
Implement Your Plan Step One: Establish a Self-Directed Retirement Account To invest in real estate, your retirement funds must be managed by a self-directed custodian or trust company. Traditional brokerages won’t suffice. A self-directed account enables you to select alternative investments like real estate, which is classified as a non-taxable event. You’re not liquidating your IRA or 401(k) but merely transferring it to a custodian that offers a broader range of investment options. This process incurs no penalties or taxes, just increases your control.
Step Two: Fund the Account The transfer process is based on the account types—IRA to IRA, Roth to Roth, 401(k) to 401(k), or IRA, depending on your eligibility. Funds are moved through a direct transfer, not through your personal bank account. The time needed for transfers can vary significantly, taking anywhere from days to weeks. Once the funds are in your account, you can proceed to the next stage.
Step Three: Create a Retirement-Owned LLC This step provides flexibility. Your retirement account establishes an LLC for specific purposes. This LLC is owned by your retirement account, with you as the manager. This arrangement facilitates quicker transactions, clearer asset separation, and simplified management. The LLC handles property purchases, rent collection, paying expenses, and holding reserves. You oversee the process, but you do not personally profit from it.
You cannot pay yourself or contribute personal labor. This investment belongs to your retirement account, not to you personally.
Step Four: Capitalize the LLC and Purchase Property Once the LLC is established, your retirement account funds it. The LLC will open its bank account and function as any typical real estate buyer, managing offers, due diligence, closing, and management processes. It’s essential to plan prudently. Your retirement account should have sufficient cash for the purchase, reserves, repairs, furnishings, and ongoing expenses since you cannot infuse extra personal funds down the line—the investment must be self-sufficient.
Understand Prohibited Transactions Before Starting This aspect can be daunting, but the rules are straightforward. You, your spouse, parents, children, and their spouses are considered prohibited parties. You cannot use the property for personal purposes, manage it for compensation, or act as the realtor, nor can your spouse.
The IRS's intent is to prevent self-dealing. Engage third parties, hire property managers, pay market rates—all reasonable actions that help avoid prohibited transactions. As long as you adhere to the rules, you’ll be on stable ground.