How to use a self-directed IRA to finance a rental property

Written on September 27, 2017 by , updated on December 3, 2019

Investing with IRAsFinding the financial resources to purchase a rental propertywhether it’s your first or your 20thcan be challenging.

Savvy real estate investors know IRAs can help fund rental property investments while creating real tax advantages; let’s talk about how to leverage them.

1. Your retirement account

Many investors don’t realize that an IRA, 401(k), or other retirement account doesn’t have to be limited to stock, bond, or mutual fund investing. Investors can self-direct IRAs and other accounts to invest in a variety of assets.

Allowable IRA investments include real estate, tax liens, promissory notes, private entities, and more.

Self-directed investing is nothing new. Since IRAs were introduced in 1974, the IRS has only listed a handful of items that are not permitted in an IRA, such as collectibles. See IRS Publication 590 for more information. Otherwise, if you follow IRS guidelines, investments in real property are possible.

2. Other people’s retirement accounts

Don’t have much saved in your retirement account yet? There is more than $8.2 trillion sitting in Americans’ individual retirement accounts, according to the latest report from the Investment Company Institute.

Once you identify an investor with IRA capital, it’s possible to borrow money from their IRA using a promissory note. The money is paid back, along with any interest to the retirement account. 

3. An IRA plus other funding

If you don’t have enough in your IRA for the investment but would like to begin self-directing your account, there are still other options.

It’s possible to co-invest using your account with one or more self-directed accounts, and/or other non-retirement account money.

Any profits from the investment would flow back to the funding sources in the same proportion in which it was used to fund.

For example: If your self-directed IRA provided 60 percent of the funding and your co-investor invested the other 40 percent, 60 percent of any profits would go back into your IRA, and the remaining 40 percent would go to your co-investor. Any expenses related to the investment would follow the same rule.

Self-directed investing explained

A self-directed investment works much like any other investment in an IRA. Money from an IRA or other account is used to invest in an asset, and that asset is then held in the IRA. All profits and expenses flow through the retirement account.

IRAs provide tax advantages, which differ depending on which type of account you own. A traditional IRA has tax-deferred status, which means you pay taxes when you withdraw from the account. With a Roth IRA, you’re taxed when you make contributions, and any profits or qualified withdrawals are tax-free.

How to get started with self-directed investing

As with any investment, your due diligence is key. Before making an investment decision, consult with a tax, legal, or financial professional.

You should also be aware of the IRS’s limitations for IRA investing. The IRS provides guidelines in IRS Publication 590 for IRA investments regarding:

  • Disqualified individuals
  • Indirect benefits
  • Unqualified Business Income Tax (UBIT)

Also, make sure you’ve found a self-directed IRA provider. Not all custodians offer self-directed accounts.

Want to know more about self-directed IRAs?

For more information about investing in real estate with an IRA, download this free report: Self-Directed Real Estate 101: How does real estate investing in an IRA really work?

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