Invest in Real Estate with a Self-Directed IRA

Published on: Thursday, August 07, 2008

Written by: David Nilssen

How To Invest In Real Estate With Your IRA

It’s a little-known fact that you can invest your tax-deferred or tax-free retirement funds in real estate. In fact, you can invest your retirement funds into nearly anything. The internal revenue code specifies only what an IRA cannot invest in, and those things are life insurance and collectibles. This leaves your investment choices nearly endless.

Increasing numbers of people are discovering the many benefits of investing in real estate with their retirement funds. Like returns from securities investments, the returns from an IRA real estate investment are realized tax-deferred in the retirement account, but unlike stocks and bonds, real estate is a tangible investment which the investor can see and have a direct hand in appreciating its value.

Set up a self-directed IRA account

To invest in real estate with your IRA, you must first create an account that supports investments in non-traditional assets. These types of accounts are commonly known as self-directed IRAs. There are two ways to create a self-directed IRA.

Self-directed IRAs with a self-directed custodian

These companies act very similarly to your existing IRA custodian, but they allow non-traditional investments. Self-directed custodians hold your IRA funds in their accounts and direct those funds on your behalf when you wish to make an investment.

For example, if you decide to purchase real estate with your self-directed IRA, you will apply for an investment through the custodian. Approval for this investment can take a matter of days or weeks, depending on the custodian with which you work. Once the investment is approved, the custodian issues a check directly to the seller for the purchase of the property.

Fees for self-directed custodial accounts are generally based on the value of the assets in the account (typically 0.5 percent of the total value), plus transaction fees which range from $5 to $200 per transaction, depending on how fast the funds are needed and the method of delivery.

Self-directed IRAs through a self-directed IRA/LLC

These accounts start out similarly to self-directed custodial accounts, but go one step further. Companies that offer self-directed IRA/LLC services will transfer your funds to a self-directed custodial account with a preferred partner, typically at a dramatic annual-fee discount. They will then prepare a customized limited liability company (LLC) on your behalf. The self-directed IRA/LLC company will then direct your retirement funds into the LLC. You can then readily access these funds through the LLC bank account.

Most self-directed IRA/LLC companies will instruct you to open a checking account for the LLC, which will enable you to make investments instantaneously. This means that once you have decided which property you wish to purchase as an IRA investment, you will simply purchase the property in the name of the LLC and will write a check directly to the seller from the LLC bank account.

Fees for self-directed IRA/LLC clients typically include a one-time setup fee, based on the complexity of the setup (multiple parties or multiple accounts can invest in the same LLC or different LLCs), plus a flat annual fee, usually around $150. There are no transaction fees or asset-based fees with these accounts.

Buying real estate as an IRA investment

Whichever account you establish, the process to purchase a piece of real estate as an IRA investment is fairly simple. You must make the purchase in the name of your IRA or in the name of the LLC, and you must pay for the property with IRA funds.

Avoiding prohibited transactions

When investing in real estate with an IRA, one should be careful to avoid prohibited transactions. Although IRS Code only bars your IRA from investing in life insurance and collectibles, it has additional provisions in place to keep you from gaining any personal benefit from your IRA investments before you reach the age when the government says you can start taking penalty-free distributions (age 59 1/2).

One such prohibited transaction is that the IRS mandates that you cannot invest with any "disqualified parties." Disqualified parties include yourself, any direct ascendants or descendants (i.e., parents and children), your spouse, spouses of your descendants, and people with a fiduciary responsibility to your account (i.e., accountants and financial advisors).

Because of these restrictions, you could not buy a home with your IRA that you would live in or that would be rented out to your grandparents. The IRS has put these codes in place to make sure that your IRA money is used for investment purposes only. Luckily, even with these restrictions in place, there are limitless opportunities for arms-length transactions that will help grow your IRA.

For more information on disqualified parties and other prohibited transactions, visit Guidant Financial Group’s FAQs.

David Nilssen is the president, CEO of Guidant Financial Group, Inc. Guidant Financial creates retirement accounts that allow investments in both traditional (stocks, bonds, mutual funds) and non-traditional (real estate, tax liens, personal loans, small businesses, etc.) investments.