How to Buy Real Estate With an IRA

Real estate is one of the most common investments held in a self-directed IRA. An IRA can own single-family rental properties, multifamily properties, commercial real estate, raw land, and many other types of real estate investments. The key is understanding that when retirement funds are used to make the investment, the IRA owns the property, not the IRA owner personally.

For many real estate investors, this provides an opportunity to invest retirement dollars in an asset they already know and understand. Rather than limiting their retirement account to the stocks, bonds, mutual funds, and ETFs typically available through a brokerage firm, a self-directed IRA allows the account owner to direct retirement funds into real estate and other alternative investments.

There can also be significant tax advantages. Rental income and gains from investment real estate remain inside the retirement account without current taxation to the IRA owner. Traditional IRA funds grow tax-deferred, while qualified Roth IRA distributions can ultimately be tax-free.

Buying real estate with an IRA is not particularly complicated, but the rules are different from buying property personally. The IRA must receive the income and pay the expenses, and the IRA owner and other disqualified persons cannot personally use or improperly benefit from the property.

There are also several ways to structure the investment. Your IRA can own the property directly, it can own real estate through an IRA/LLC, it can invest alongside other investors in properly structured transactions, and it can even use a nonrecourse loan to finance part of the purchase.

Before getting into the purchase process, it helps to understand why an IRA can own real estate in the first place and what makes a self-directed IRA different from a typical brokerage IRA.

Can You Buy Real Estate With an IRA?

Yes. An IRA can own real estate.

A “self-directed IRA” is not a separate type of IRA under the tax code. It is an IRA administered by a custodian that permits the account owner to direct investments into assets beyond the publicly traded investments commonly available through brokerage firms.

Most brokerage firms do not allow direct ownership of rental properties, raw land, private companies, promissory notes, and similar alternative assets. That is generally a limitation imposed by the financial institution rather than a rule requiring every IRA to invest only in publicly traded securities.

To buy real estate directly with retirement funds, you will need a custodian that administers self-directed IRA real estate investments. Directed IRA allows clients to use Traditional IRAs, Roth IRAs, SEP IRAs, and other eligible self-directed retirement accounts to invest in real estate and other alternative assets.

IRA-owned property must be maintained for the benefit of the retirement account. It cannot be used personally by the IRA owner or other disqualified persons. Rental and investment real estate generally receives the normal tax treatment associated with the retirement account, although debt financing and certain real estate business activities can create additional tax considerations.

Once you have a self-directed IRA that allows real estate investments, the mechanics are fairly straightforward. The most important rule is that the IRA is the investor and owner of the property, not you personally.

How Buying Real Estate With an IRA Works

If your self-directed IRA purchases a rental property, the purchase contract should identify the IRA as the buyer, the deed should reflect ownership by the IRA, and purchase expenses should be paid using retirement account funds. Once the property is acquired, rent goes back to the IRA and property expenses are paid from retirement funds.

For example, if John Smith has a Roth IRA at Directed IRA and the Roth IRA purchases a rental property, title would generally be held as:

Directed Trust Company FBO John Smith Roth IRA

John Smith does not own the property personally. His Roth IRA owns the property.

That distinction continues throughout the life of the investment and is one of the most important rules for real estate investors to understand.

There is also an important misconception worth addressing early. Your IRA does not necessarily need enough cash to purchase the property outright.

An IRA can use financing to acquire real estate. However, because the IRA owner is a disqualified person to his or her IRA and cannot extend personal credit to the IRA, financing is structured as a non-recourse loan. With a non-recourse loan, the lender looks to the investment property securing the loan rather than relying on the IRA owner’s personal guarantee.

This means an IRA with $200,000 is not limited to purchasing a property costing $200,000 or less. The account may be able to combine IRA cash with permissible financing to acquire a more expensive property.

Using debt can create a separate tax known as unrelated debt-financed income, or UDFI. We will explain both nonrecourse financing and UDFI in greater detail below.

With those basic rules in mind, the actual purchase process can be broken down into five steps.

Step 1: Open and Fund a Self-Directed IRA

The first step is establishing a self-directed IRA with a custodian that allows direct real estate investments.

Most investors fund a self-directed IRA by transferring cash from an existing IRA or rolling funds from an eligible former employer retirement account. Depending on the account and the investor’s circumstances, annual contributions may also be used.

Suppose you have $500,000 in a Traditional IRA at a brokerage firm but want to use $150,000 to buy real estate. You do not necessarily need to move the entire IRA.

You could open a self-directed Traditional IRA at Directed IRA and transfer $150,000 from the existing Traditional IRA. You would then have two Traditional IRAs. One could continue holding publicly traded investments at the brokerage firm, while the self-directed IRA could hold the real estate.

A properly completed transfer between IRAs of the same tax type generally does not create a taxable distribution merely because the IRA custodian changes.

The same concept applies to Roth IRAs. You can generally transfer all or part of an existing Roth IRA to a self-directed Roth IRA without converting the funds or changing their Roth tax character.

Step 2: Find the Real Estate Investment

Once the self-directed IRA is established and funded, you identify the property.

The custodian does not choose the investment for you.

Directed IRA is a directed custodian. We administer the retirement account and process investments at the account owner’s direction, but we do not sell investments, recommend properties, or perform investment due diligence.

The IRA owner is responsible for evaluating the investment. With real estate, that may include reviewing comparable sales, rental history, leases, inspection reports, title, insurance costs, property taxes, anticipated repairs, market rents, zoning, property condition, and the experience of any sponsor or operator involved.

This is an important distinction in self-directed investing. The custodian determines whether it can administratively hold an asset. It does not determine whether the property is a good investment.

Step 3: Make the Offer in the Name of the IRA

When an IRA is purchasing real estate directly, the IRA should be identified as the buyer on the purchase contract.

For example:

Directed Trust Company FBO John Smith Roth IRA

The IRA owner should not personally enter into the purchase contract with the intention of later assigning his or her contractual rights to the IRA. A sale, exchange, or other transaction between an IRA and a disqualified person can create a prohibited transaction under IRC § 4975.

The better approach is to establish the self-directed IRA before entering the investment and have the retirement account identified correctly from the beginning.

When the IRA owns real estate directly, the custodian will generally execute documents necessary to bind the IRA after receiving the account owner’s direction and required documentation.

This is one reason it is useful to have the self-directed IRA established and funded before you are facing a short closing deadline.

Step 4: The IRA Pays the Purchase Expenses

Because the IRA is buying the property, the buyer’s expenses should be paid with IRA funds.

That includes items such as earnest money, inspection and due diligence expenses, down payments, closing costs, and the cash required to complete the purchase.

A common mistake occurs when a real estate investor signs a contract and personally writes the earnest money check, planning to have the IRA reimburse the amount later. That is not the proper structure.

If the IRA is purchasing the property, the earnest money should come from the IRA. If the IRA orders an inspection, the inspection expense should be paid from the IRA. Property expenses should remain separate from the IRA owner’s personal funds.

Real estate investors often need to change some of their normal habits when purchasing through a retirement account. You may routinely pay an inspection with a personal credit card when buying property personally. With an IRA transaction, remember that the retirement account is the investor.

Step 5: Close on the Property

Once due diligence is complete and you decide to proceed with the investment, you direct the self-directed IRA custodian to complete the transaction pursuant to the custodian’s current investment procedures.

When the IRA owns the property directly, the deed is titled in the name of the IRA. Directed IRA then sends the IRA’s funds to the title company or other closing agent according to the account owner’s investment direction and the transaction documents.

Once closing is complete, the property becomes an asset of the retirement account. You do not personally own the property simply because you are the beneficiary of the IRA.

Closing is only the first part of owning real estate in an IRA. Once the property is acquired, the same separation between the IRA and the account owner continues to apply to rental income, expenses, repairs, management, and eventual sale.

What Happens After Your IRA Owns the Property?

The same principle applies after closing. Income belongs to the IRA and expenses belong to the IRA.

If an IRA-owned rental generates $3,000 per month, the rent should be paid back to the retirement account rather than deposited into the IRA owner’s personal checking account. If the property needs a $5,000 repair, the expense should be paid using IRA funds rather than personally by the account owner.

There are three common ways to administer income and expenses associated with IRA-owned real estate.

The first is direct ownership through the IRA. Rent goes to the IRA, and when expenses are due the account owner directs the custodian to pay them from the account.

The second is using an independent property manager. The IRA engages the property manager, who can collect rent, pay authorized property expenses, and return net cash flow to the IRA. Care should be taken when engaging and compensating anyone who may be a disqualified person to the IRA.

The third is using an IRA-owned LLC, commonly referred to as an IRA/LLC or Checkbook IRA. The IRA owns the LLC, the LLC owns the property, and the LLC maintains a business checking account through which rental income and property expenses can be administered.

Which option makes sense depends largely on the property and how much ongoing activity is required. Direct ownership may work well for raw land or a passive property with very few transactions. A rental property with recurring income and expenses may be more efficiently administered through a property manager or an IRA/LLC.

Can You Manage Real Estate Owned by Your IRA?

An IRA owner can make investment decisions and oversee IRA-owned real estate, but there are important limits on personally providing services to the property.

You can identify the property, negotiate the transaction, evaluate tenants, select contractors, approve repairs, monitor the investment, and make investment decisions for the IRA.

The problem arises when the IRA owner crosses from managing the investment into personally providing labor or services to the IRA-owned asset.

For example, assume your IRA owns a rental property that needs to be painted between tenants. You can obtain bids, select a painter, approve the work, and direct retirement funds to pay the contractor. You should not personally perform the painting as a substitute for hiring a third party.

The same concern applies to construction, plumbing, electrical work, landscaping, and other physical labor.

The practical distinction is between directing and managing an IRA investment and personally providing services to it. The distinction between directing an investment and personally benefiting from or providing impermissible services to it is part of the broader prohibited transaction rules that apply to all self-directed IRA investments.

Prohibited Transactions and IRA-Owned Real Estate

Real estate is allowed in an IRA, but IRC § 4975 restricts certain transactions involving the IRA and people known as disqualified persons.

Disqualified persons include the IRA owner and certain family members, fiduciaries, service providers, and entities related to or controlled by disqualified persons. These rules are designed to prevent self-dealing and the use of retirement assets for current personal benefit.

In real estate transactions, prohibited transaction issues commonly arise when the IRA owner or another disqualified person receives a current personal benefit from the IRA’s property.

For example, your IRA cannot buy a vacation home and allow you to stay there. Your IRA cannot buy property from you personally. You cannot use the IRA as collateral for your personal borrowing, and you cannot personally guarantee financing used by the IRA.

Property expenses should also be paid using IRA funds rather than the IRA owner’s personal money, and an IRA owner should not personally receive compensation or commissions from the IRA’s real estate transaction.

The consequences can be substantial. A prohibited transaction involving the IRA owner can cause the account to lose its tax-advantaged status and be treated as distributed.

For a deeper explanation of disqualified persons and prohibited transactions, see our complete guide to Prohibited Transactions in a Self-Directed IRA.

Can an IRA Borrow Money to Buy Real Estate? Understanding Nonrecourse Loans

As discussed earlier, an IRA does not have to purchase real estate entirely with cash. It can use leverage, but the financing rules are different from those that apply when you purchase property personally.

The important restriction is that the IRA owner and other disqualified persons cannot personally extend credit to the IRA or personally guarantee its loan. Consequently, IRA real estate financing is generally structured as a non-recourse loan.

With a non-recourse loan, the lender makes the loan based on the investment asset securing the debt. If the loan defaults, the lender’s remedies are limited by the nonrecourse terms rather than extending personally to the IRA owner.

For example, suppose an IRA wants to purchase a $300,000 rental property. The IRA could potentially use $180,000 of retirement account cash and obtain a $120,000 non-recourse loan for the remaining purchase price, subject to the lender’s underwriting and loan terms.

The IRA owner does not personally guarantee that $120,000 debt.

This means real estate investors can use leverage inside an IRA, although the financing mechanics differ from a conventional personally guaranteed mortgage.

Directed IRA explains this structure in more detail in Can My IRA Get a Loan to Buy Real Estate?.

There is also a tax consequence that needs to be incorporated into the investment analysis.

UDFI: What Happens When an IRA Uses Debt?

Investment income inside an IRA ordinarily benefits from the tax treatment of the retirement account. Debt-financed property is an important exception.

IRC § 514 contains rules for unrelated debt-financed income, commonly called UDFI. When borrowed funds are used to purchase income-producing investment property, a portion of the income attributable to acquisition indebtedness can become subject to unrelated business income tax.

Consider an IRA that purchases a $300,000 rental property with $150,000 of IRA cash and $150,000 of debt. In simplified terms, half of the property was financed with borrowed funds. A corresponding portion of net income may therefore be subject to UDFI.

The actual calculation is more complicated than simply multiplying income by the original loan percentage. The calculation considers average acquisition indebtedness, adjusted basis, income, expenses, and other relevant items.

UDFI can also apply to gain when debt-financed property is sold.

This does not automatically make leverage a poor strategy. The relevant question is whether the investment benefits of using leverage outweigh the additional tax and administrative costs.

When an IRA has sufficient unrelated business taxable income, Form 990-T may be required. Because these calculations can be technical, investors using nonrecourse financing should work with a CPA or tax attorney familiar with self-directed retirement accounts.

You can also read our detailed explanation of UDFI tax in a Self-Directed IRA.

Should You Use an IRA/LLC to Own Real Estate?

As noted above, one way to administer IRA-owned real estate is through an IRA/LLC. An IRA does not need an LLC to buy real estate, but the structure can provide significant administrative convenience for certain types of real estate investors.

The basic structure looks like this:

IRA → LLC → Real Estate

The self-directed IRA invests cash into a newly established LLC in exchange for membership interests. In a common structure, the IRA owns 100% of the LLC, and the IRA owner serves as the non-compensated manager of a properly structured manager-managed LLC.

The LLC establishes its own business checking account. The retirement funds invested into the LLC are deposited into that account, and the LLC purchases and operates the real estate.

If the LLC is called XYZ Investments, LLC, the purchase contract and deed are in the name of XYZ Investments, LLC. Rent goes to the LLC checking account, and the LLC pays property expenses from that account.

This ability to administer transactions through an LLC business checking account is why the structure is sometimes called a Checkbook IRA/LLC.

When an IRA/LLC May Be Useful

Consider a rental property. The property may generate rent every month while also requiring payments for landscaping, repairs, utilities, insurance, taxes, and other expenses.

With direct IRA ownership, these transactions generally flow through the custodian or a properly engaged property manager. With an IRA/LLC, the LLC maintains its own checking account. The manager can execute authorized investment transactions through the LLC without sending every check through the IRA custodian.

Another example is real estate purchased at auction. Some auctions require deposits or payment within very short timeframes. Having funds already available in the IRA/LLC bank account can make it easier to satisfy those investment deadlines.

An IRA/LLC may therefore be particularly useful for rental properties, multiple properties, rehab projects, auctions, and other investments with frequent transactions.

Directed IRA has a separate resource explaining why real estate investors use IRA/LLCs.

When an IRA/LLC May Not Be Necessary

An IRA/LLC is a tool, not a requirement. If your IRA is buying a piece of raw land that will sit for several years with very few transactions, direct IRA ownership may be perfectly adequate.

Likewise, an IRA holding one rental property that is fully administered by an independent property manager may not need the additional transactional convenience of an IRA/LLC.

An LLC also creates another legal entity that must be properly established and maintained. Depending on the state and circumstances, that can involve formation costs, state fees, registered agent obligations, annual filings, and other administrative requirements.

The question is whether the additional control and administrative convenience justify the additional structure.

An IRA/LLC Does Not Change the IRA Rules

An IRA/LLC does not provide a way around prohibited transaction rules.

If a transaction would be prohibited when completed directly through an IRA, putting an IRA-owned LLC between the retirement account and the transaction generally does not make the transaction permissible.

You cannot use an IRA/LLC to purchase a vacation property and then stay in it personally. You cannot pay yourself compensation for managing your IRA-owned LLC merely because you are the LLC manager. You cannot personally guarantee a loan simply because the LLC, rather than the IRA directly, is the named borrower.

The IRA/LLC operating agreement also needs to be properly structured for IRA ownership. A standard operating agreement drafted for a personally owned small business may contain provisions inappropriate for an IRA-owned company.

You can learn more about the structure in our Checkbook IRA/LLC guide.

Can an IRA/LLC Use Non-recourse Financing?

Yes.

An IRA/LLC can use properly structured non-recourse financing to purchase real estate. The addition of the LLC does not eliminate the restrictions on personal guarantees or the potential UDFI consequences from using acquisition debt.

The IRA owner still cannot personally guarantee the loan.

The LLC structure changes how the investment is administered. It does not change the underlying retirement account rules.

Can an IRA Invest in Real Estate With Other Investors?

Your IRA does not necessarily need to own 100% of a property.

Retirement funds can participate in properly structured co-investments, including ownership alongside other retirement accounts or unrelated investors. Multiple IRAs can also invest into an LLC or other entity that acquires real estate.

These transactions require careful documentation. Ownership percentages should be clearly established, and income and expenses should be allocated consistently with the ownership structure.

Greater caution is warranted when an IRA is investing alongside the IRA owner personally or another disqualified person. Related-party co-investment can create prohibited transaction and self-dealing concerns depending on how the investment is formed, operated, financed, and changed over time.

Anyone considering a related-party co-investment should obtain advice from a qualified attorney or tax professional before entering the transaction.

Rental Property Versus Fix-and-Flips and Real Estate Development

Not every real estate strategy receives identical tax treatment inside an IRA.

Rental property held for investment generally produces rental income, while the eventual sale of investment property generally produces investment gain. Those categories ordinarily benefit from the retirement account’s tax treatment, subject to issues such as UDFI when debt is involved.

The analysis can change when an IRA is carrying on an active real estate business.

An IRA that repeatedly acquires property, develops or rehabs it, and sells property in the ordinary course of a business may generate unrelated business taxable income.

There is not a simple rule that an IRA can complete a certain number of flips each year before UBIT applies. The facts and circumstances matter.

That does not mean an IRA cannot invest in development projects or fix-and-flips. It means investors using these strategies should consider UBIT before investing rather than discovering the tax consequences afterward.

For more detail, see our guide to UBIT in a Self-Directed IRA.

Don’t Overextend the IRA

One of the most practical problems in IRA-owned real estate is putting nearly every available retirement dollar into the purchase and leaving too little liquidity for the property afterward.

Suppose an IRA has $310,000 and purchases a $300,000 rental property. The account may now own a valuable investment, but it has very little cash available.

What happens when the property needs a $15,000 roof? What happens after an extended vacancy? What happens when insurance and property taxes are due?

Remember that property expenses should be paid by the IRA. The account owner should not solve a cash shortage by casually writing a personal check.

Before buying the property, estimate not only the purchase price but also the capital required to operate the investment. Maintaining adequate cash reserves inside the IRA or IRA/LLC can prevent a liquidity problem from turning into a compliance problem.

Annual Valuation Requirements for IRA-Owned Real Estate

IRA custodians must report the year-end fair market value of IRA accounts, including accounts holding assets that do not have readily available public market prices.

Determining the value of publicly traded securities is relatively straightforward. Real estate does not have a daily quoted market price.

As a result, owners of self-directed IRAs holding real estate need to comply with their custodian’s annual valuation procedures. Depending on the property and the purpose of the valuation, supporting information may include comparable market information, a broker price opinion, comparative market analysis, appraisal, or other appropriate valuation evidence.

More formal valuation documentation may be appropriate when the valuation itself has a direct tax consequence, such as an in-kind distribution or Roth conversion.

Follow your custodian’s current fair market value requirements and provide updated real estate valuations when required.

We have now covered the primary rules, financing options, and ownership structures. The following examples show how those pieces come together in an actual transaction.

Example: Buying a $300,000 Rental Property With a Self-Directed IRA

Assume John has $400,000 in a Traditional IRA at a brokerage firm and wants to purchase a $300,000 rental property.

John opens a self-directed Traditional IRA at Directed IRA and transfers $200,000 from his existing Traditional IRA. The remaining retirement funds stay at his brokerage firm.

John identifies the $300,000 rental property and decides to use $180,000 of IRA cash toward the purchase while seeking a $120,000 nonrecourse loan for the balance.

The purchase contract identifies the IRA as the buyer:

Directed Trust Company FBO John Smith IRA

John directs Directed IRA to proceed with the investment pursuant to its transaction procedures. The IRA provides the earnest money, inspection and due diligence costs, cash portion of the purchase price, and closing expenses.

A lender approves the $120,000 non-recourse loan. John does not personally guarantee the debt.

At closing, the deed is recorded in the name of the IRA. After acquisition, rent goes back to the retirement account and property expenses are paid using IRA funds.

John can make investment decisions, select contractors, approve repairs, and oversee the property, but he does not personally perform prohibited services or use the property himself.

Because the IRA used acquisition debt, John also works with a tax professional to determine the account’s UDFI and Form 990-T obligations.

Finally, he keeps adequate cash inside the IRA to cover vacancies, repairs, property taxes, insurance, and other expenses.

That is the basic structure of a leveraged real estate investment held directly by a self-directed IRA.

Example: Buying the Property Through an IRA/LLC

Now assume John intends to own several rental properties and expects significant ongoing transaction activity.

Instead of having the IRA purchase the property directly, John establishes a properly structured manager-managed IRA/LLC.

His IRA owns 100% of XYZ Investments, LLC, and John serves as its non-compensated manager. Directed IRA invests the designated retirement funds into the LLC, which opens a business checking account.

XYZ Investments, LLC then contracts to purchase the $300,000 rental property.

The purchase contract and deed identify:

XYZ Investments, LLC

The LLC uses IRA-derived funds in its bank account for the cash portion of the purchase and obtains permissible nonrecourse financing for the balance.

After closing, tenants pay rent to XYZ Investments, LLC. Property expenses are paid from the LLC bank account. John can act as manager and sign authorized contracts and checks for the LLC, but he cannot personally use LLC assets, personally guarantee the financing, or receive prohibited compensation from the IRA-owned company.

The IRA/LLC gives John additional administrative control. It does not change the underlying IRA rules.

Real Estate IRA Do’s and Don’ts

How to Get Started With Directed IRA

Buying real estate with an IRA allows real estate investors to use retirement dollars in an asset class they know and understand while maintaining the tax advantages of the retirement account.

The process generally starts by opening the appropriate self-directed retirement account, funding it through an eligible transfer, rollover, or contribution, and then identifying the real estate investment you want the account to purchase.

From there, the rules follow a consistent theme. The retirement account owns the investment, receives the income, and pays the expenses. You direct the investment while keeping IRA assets separate from personal assets and avoiding transactions with disqualified persons.

If financing is needed, properly structured nonrecourse debt can allow an IRA to use leverage rather than purchasing the entire property with cash. If the investment requires frequent transactions or greater administrative control, an IRA/LLC may also be appropriate.

At Directed IRA, we specialize in administering self-directed retirement accounts holding real estate, IRA/LLCs, private investments, and other alternative assets. Directed Trust Company serves as the regulated custodian while you select and direct the investments.

If you’re considering purchasing your first rental property with an IRA, evaluating an IRA/LLC, or trying to determine how nonrecourse financing would work with your retirement account, you can book a call with the Directed IRA team to discuss the account and transaction process.

Directed IRA does not sell investments or determine whether a particular real estate investment is appropriate for you. Our role is to provide the self-directed retirement account, custody and administer the assets, process your investment directions, complete required custodial reporting, and provide education to help you understand how self-directed retirement accounts work.

Disclosure: This article is for educational purposes only and does not constitute investment, legal, or tax advice. Directed Trust Company performs the duties of a directed custodian and does not provide due diligence on prospective investments, sponsors, or service providers and does not sell investments or provide investment, legal, or tax advice. Investors should consult their tax, legal, and financial advisors regarding their specific circumstances, particularly when considering prohibited transactions, nonrecourse financing, UBIT, UDFI, related-party investments, or an IRA/LLC.