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Buying Real Estate in Your Self Directed Roth IRA to Escape Taxes and Maximize ROI – Pros, Cons and Other Considerations

In this article I want to discuss buying real estate in IRA – Individual Retirement Accounts to maximize your long term return on investment.

Many successful professionals are looking for alternative investments as they often think about what to do with their excess cash. While real estate investing is often one option, doing so in a manner that allows them to escape taxes on the cash flow and long term capital gains legally is a method only few are aware of, and even fewer who apply it.

Buying real estate in a IRA is a topic that is very dear to me. I have been investing in real estate both outside and inside my Roth IRA and have done very well over the years.

In keeping up with changes and trends in the practice, I have come across several pieces of conflicting information. I have also noticed many real estate investors would be interested in doing this but they don’t get around to it because of either lack of information, resources and / or the know-how.

This is my attempt to describe how to invest in real estate from within an IRA, and the pros and cons involved in this style of investing.  I hope you find it beneficial.

My Real Estate Investment Rationale

Real estate has been an excellent avenue for me to build wealth / net worth over the years.  It is an investment where you can highly leverage your capital (up to 100% vs. 50% max when trading stocks on margin), benefit from significant tax breaks, earn short term cash flow and bank on long term appreciation in asset value.

I started investing in real estate before I invested in a small business and started various online businesses. I still do and plan on continuing to invest in it as long as I can think of.  With more cash flow coming in now from my various niche websites, I have shifted my real estate investments into a higher gear.  I view real estate investment as a solid compliment to my existing businesses, and an avenue where I can “park” some of my excess cash while enjoying an above average return on investment (ROI).

The specific reasons why I prefer buying real estate in my IRA account is because I do not pay taxes on the rent income my properties generate, as well as on the capital gain on sale upon selling the properties all while keeping the Internal Revenue Service (IRS) at bay.  This in turn boosts the overall ROI, making this type of investment more favorable for me compared to many other alternatives.

In many states, assets in a retirement account are also protected from several attempts to intrude such as a lawsuit, which is an added and significant collateral benefit.

What Types of Real Estate Can You Invest in Through Your IRA

The IRS allows investment in pretty much any type of real estate in any type of IRA.  You can own raw land (improved or unimproved), condominiums, single family and multi-family homes, commercial properties such as shopping complexes and apartment complexes, co-ops, apartment buildings, mortgage notes, rehab homes, rental properties and more.

That said, following the rules and regulations is extremely important or you may be faced with an unexpectedly large tax bill that can leave you scrambling for cash.  I highly recommend taking time to understand IRS Publication 590 as well as the Internal Revenue Code (IRC) 408.

Do You Need a Special Kind of an IRA Account to Invest in Real Estate?

If you currently have a basic IRA account, you will need to close it out and open what’s called a “self-directed IRA”.  Many banks and brokerages (i.e. TD Ameritrade) can help you open one, but they will usually restrict you from buying real estate in your IRA.

Your investment options are typically limited to the products they offer. Therefore, you will have to find companies that offer real estate investing under their self directed IRA plans.  Finding a good partner to work with that doesn’t kill you on fees and commissions is arguably the toughest challenge in this process.

The reason why many do not offer self directed IRAs is that as the custodians of the accounts, these institutions would still be responsible for all the paperwork involved in administering the account for you.  This does not mean they are liable for the investments within the account (you are), but they rather not deal with the added headaches.

Most are simply not trained and prepared to do so. Some administrators on the other hand are willing to deal with the paperwork, but they charge you for it in form of account administration fees.

Does It Cost More to Have a Self Directed IRA?

Yes it does.  If you open a regular IRA account with a brokerage, typically you don’t pay any fees providing you have a certain account balance.  You do pay commissions on trades when you buy and sell securities.

With a self-directed IRA, you will pay approximately half to one and a half percent (.5 – 1.5%) of your asset value annually.  Say you have approximately $300,000 in assets in your IRA, you are looking at an annual fee between $1,500 to $4,500.

As you can imagine, choosing a company that offers even a few basis points less in administration fees can make a huge difference. That said, the percentage fee typically goes lower the higher your balance or asset value becomes. I have heard as low as .2%, but I am personally not there yet.

When I started buying real estate in my IRA, a fixed percentage fee structure was the only one I saw in the marketplace. Recently however I have been reading about and considering fee based administrators who charge on a per transaction basis.  Since I don’t transact much within my IRA, this option is starting to sound more favorable for me.  The jury is still out however.

Lately, I have seen a hybrid of both who charge a small fixed fee and then a per transaction fee.  Yes, thanks for adding to the confusion. And to make it worst, this is the model most administrators are moving toward.

From experience, I suggest talking to several administrators before settling with one.  The company that offers the lowest fee is not necessarily the best one to go with. Also ensure the administrator has a stellar track record.  Avoid those who are new to the business because 1) they might not know much about what they are doing and 2) your assets will be tied up for some time if the administrator was to go belly up.

Questions to Ask Self Directed IRA Administrators

Here are just a handful of thought starters that you can incorporate in your research for the best self directed IRA administrator for you:

  • Do they have a local presence near you?
  • What is their asset base or assets under control?
  • How many clients do they have?
  • Can you be provided with a few clients to contact for reference?
  • How long they have been in business?
  • Ask about fees and be clear on the fee structure
  • Check their Better Business Bureau (BBB) records
  • Talk to their personnel and gauge their level of knowledge
  • Clarify that they will support the investments you have in mind to avoid surprises
  • Ask for financial statements to assess financial viability

One other thing that you may want to consider is whether the administrator has the expertise to help you select suitable real estate.  This is not a requirement in my books, but a helpful characteristic if you are not a seasoned real estate investor.

I personally do my real estate dealings on my own, from finding the property (with the help of an agent) to buying it, renting it out and selling it. However, there are administrators that specialize in this because they recognize that the biggest reason why people open self directed IRA accounts is to invest in real estate.

I will tell you who I do business with below….

Opening a Self Directed IRA

Once you have settled in on the administrator of your choice, setting up the self directed IRA is a breeze.  Your administrator will hold your hand at each step of the way as they realize this is not something an average investor does and thus the folks doing it require specific and detailed guidance.

If you have an existing IRA, you can transfer your funds to your new self directed account. If you qualify for one, my recommendation is to open a self directed Roth IRA.  If you intend on buying real estate in a IRA, you might end up with a multi-million dollar portfolio some day.  By investing within a Roth account, you won’t be liable for taxes on any of that money.

Navigating the IRS

The IRS is the biggest fear factor precluding investors from pursuing this type of investing. However, done properly, there is nothing to fear. I do however acknowledge that the rules involved here can be quite confusing, therefore investors should take ample time to learn the regulations and get comfortable with them.

I haven’t had personal experiences with this issue, but I know a few individuals who upon my suggestion, wanted to buy property in their IRA accounts. However, they wanted to buy a property they planned on occupying themselves, with the idea of not paying taxes on the capital gains when they sold it.

The IRS does not allow you to own property of personal use in your IRA. Although you can own any type of real estate, you cannot own one that you personally use such as your primary home, vacation home or a time share.

There are some smart pants that try to get around this by renting properties out to their spouses, which is also not allowed under IRS guidelines.  They could however rent it out to their siblings, but who wants to do that?

Here is what you can do however, which I plan on doing for at least one of my properties.  You can buy the property with the intent to rent it under your IRA.  You rent it out, collect tax free rent which you put back into the IRA, and when you retire, you take the property out as a distribution.  Once it is out of the IRA, you may do whatever you want with it.

That said, most people buy investment property in their IRA accounts. That is the true benefit of the system in my opinion. Whatever you decide to do, beware of so called “prohibited transactions”.  Again, take ample time to read the law, understand it and then apply it.

Other Important Rules to Consider When Buying Real Estate in IRA

The IRS wants you to have your investment properties in an IRA professionally managed, yet another reason why owning property for your own personal use is not permitted under an IRA.

Start researching local property managers in your area that can handle the day to day maintenance involved with your investments such as advertising, finding tenants, collecting rents, conducting repairs and maintenance, etc.

Another very important thing to keep in mind is not to co mingle funds between your IRA and other accounts.  You must track all income and expenses that pertain to your IRA and its investments.  All income from rent and proceeds from sales must go into the IRA and all expenses such as repairs and maintenance must come out of the IRA.

If you have a Roth IRA and take a distribution of principal, make note of it and track it. The IRS can audit you at any time, and you should be able to quickly and clearly reconcile all activity within your IRA at any point.

You cannot transfer property you already own into your IRA, nor can you take advantage of the depreciation deduction when filing your taxes.  That said, many investors will overlook this because the tax free cash flow and appreciation benefits overwhelmingly trump the loss of the depreciation deduction. I know I do.

Why Invest in Real Estate In Your IRA?

I was debating whether to write on this sub topic at the beginning but I wanted to provide some background to better appreciate this subtopic at this point in the post.

I have always enjoyed real estate investing for many reasons. You can read about them in my post value investing in real estate here.  Many feel that real estate gives the investor more control over investing in the stock market, and I agree with this to a far extent.

Whether real estate is the right type of investment for you is only for you to decide. But as it pertains specifically to an IRA, one specific reason you should consider buying real estate in your IRA is because you don’t necessarily need a lot of money to make money from a real estate transaction within your IRA.

How so? With just a few thousand dollars in your IRA account, you can enter in an option contract, which gives you the right to buy a specific property within a pre determined time period (i.e. 30 days).  For example, if you are one of the first ones to spot a gem in the rough, you may decide to lock in the rights to the property with the intention of “flipping” or selling it to an interested buyer.

Let’s say you find a distressed house for sale at $130,000 and know that you can sell it for $175,000 because of its true value, you may decide to pay the seller $1,000 for the right to purchase the home within 60 days. This is called a purchase option.

Within those 60 days, you reach out to your network and actively market the property for $175,000.  If you are able to find a buyer all the way up till the last day of the option, you can exercise your option and purchase the property for $130,000 and subsequently sell it for $175,000.

When I say buy I don’t mean literally paying $130,000 in cash for the house and then selling it. You would work with the different parties involved to structure the transaction so that the $175,000 proceeds are used to pay off the property of $130,000, netting you a gain of $45,000 on the sale with an initial investment of $1,000 in the purchase option.  This gain is tax free.

Another possibility is for you to purchase a purchase agreement, or the right to purchase a property upon its completion.  Purchase agreements are usually bought during development stages and are offered at a discount.  In areas where real estate is in high demand and tends to do well, purchase agreements are a great time to “get in” because the property will likely appreciate in value by the time it is completed.

When you purchase an agreement, you are purchasing a right to buy the property at a pre determined price, therefore locking it in today and benefiting from the appreciation when it is built months down the road.  When the condo market was hot a few years ago, I purchased two agreements in a hot market (popular university campus) for 5% of the purchase price.

For example, one unit was listed at $120,000, and I acquired the purchase agreement for $6,000. Not even a full year later, I sold the purchase agreement for $26,000 because the going price of the unit was then $140,000. This transaction netted me a $20,000 tax free gain on sale.

Why You Shouldn’t Own Real Estate in Your Investment Portfolio

I know you were waiting for this part. How can something be so on the up and up without a downside? In addition to some of the restrictions mentioned above under “other considerations”, here are my thoughts on some of the disadvantages of buying real estate in an IRA.

Because owning real estate already has so many deductions as is such as the mortgage interest deduction, property tax deduction and depreciation, you loose out on some of it when you buy property in an IRA.  In addition, everything in an IRA is taxed at ordinary income tax rates upon distribution as opposed to lower capital gains tax rates.

Because buying real estate in an IRA is a tax deferred or exempt investment, you can no longer deduct depreciation expense as you can say if your property was owned by a limited liability company (LLC) that you filed a schedule C for in your tax returns.

Here is the heavy hitter. Since most real estate purchases are leveraged, in other words you need a loan such as a mortgage to buy property, you will have to pay a special tax on income generated from debt financing.  In other words, if the property in your IRA is financed, you pay taxes on the income generated by that property.

This special tax is called the unrelated business income tax (UBIT), which is calculated by filing a Form 990-T along with your tax returns.  This form helps you calculate the income that is subject to the UBIT tax. Walking through an example is the best way to demonstrate how this works.

Let’s say you want to buy a rental property for $130,000 under your IRA.  Let’s say you purchase the property by putting a $30,000 down payment and getting a mortgage for the remaining $100,000. When you file your taxes, you will be obligated to pay taxes on the financed portion of the income.

Because you financed $100,000 and the value of the property is $130,000, you pay ordinary income tax on 77% ($100,000 divided by $130,000) of the income generated by the property.  You can imagine the complications involved here, particularly when you start conducting multiple transactions over time and properties are bought and sold from within your IRA.

Undoubtedly paying all cash for properties acquired under an IRA is the best and easiest approach, but who has that kind of cash?  One way to accumulate that kind of cash is by retirement plan conversions and roll-overs.  However, some roll-overs and conversions come with their own tax disadvantages such as converting a 401k plan to a Roth IRA.

There is one final kicker I’d like to add to the mix.  You cannot borrow against your property that is inside an IRA in the event you need cash. This is particularly important if you paid all cash for your property to begin with, drying up the cash in your IRA account.

Typically in a Roth IRA, you are allowed to withdraw your contributed principal tax free. But if your principal is tied up in a property, and you cannot take out a mortgage against it, the only other option you have is to sell the property to free up the capital. No one wants a fire sale.

Despite the many added costs, tax tracking and compliance obligations and headaches involved, it is my opinion that buying property in an IRA is a worthwhile endeavor and one that I’d repeatedly engage in given the chance to start over again.

The tax advantages, overall rate of return and leveraging capability to expedite building wealth and one’s net worth are worth the extra effort involved.  Not to mention that bringing in real estate into the retirement planning mix not only gives you an opportunity to cash in on potential high rates of return, but also diversifies and lowers the risk of your portfolio over the long term.

The Roth IRA is the Best Answer

I have always loved the Roth IRA from the very start, regardless of the arguments against it brought upon by many financial “experts”.  The Roth is my favorite retirement mechanism particularly for real estate investing.  Any and all profits and proceeds earned under a Roth IRA account are not subject to tax, except of course when you finance your investment properties.

Your Roth account may have enough cash or stock that you can sell for proceeds to be invested in real estate.  In fact if you do so and pay cash for the purchase of investment property in your Roth, you will not be subject to the UBIT tax.

As I mentioned earlier, rolling over existing traditional IRA and 401k plans into a Roth is also an option to consider.  Just make sure you do a “direct transfer” rather than withdrawing the funds and then re depositing it in your Roth.  If you do that, the IRS will hang on to 20% of your money and not give it back unless and until you file your tax returns.

Another thing to consider is the tax liability that will be generated when you convert a traditional IRA or a 401k account to a Roth IRA.  Traditional plans allow you to defer your taxes. In other words, you postpone paying taxes by letting your pre tax dollars grow over time.  You pay tax when you take distributions upon retirement.

When you convert to a Roth, you will have to pay the tax on those dollars today, and then deposit the after tax dollars into the Roth IRA.  But that is not so bad, particularly when you are younger in my opinion.  The younger you are, the more beneficial a Roth IRA is compared to other retirement plans for various reasons.

I will not get into my reasons because that is not what this post is about, and such reasons are personal in nature that involve very long term projections, current and future intentions, alternative use of funds and retirement vehicles, current and future tax rates, rates of return and more importantly guesses and pure speculation which both you and I truly have no clue about.

My Success with Real Estate Investing from Within an IRA

Although I am no longer eligible to contribute to a Roth IRA, I was fortunate enough to have started contributing early. I was also fortunate to transact some high ROI deals from within my Roth IRA, as well as getting lucky with a few stock picks that piled up a good stash of cash in my account.  As a result I have been able to grow and leverage the funds in my account over the years to acquire and profit from real estate.

I currently have few different real estate holdings within my IRA, mostly comprised of both high and low rise condominiums.  I have sold one property in the past, benefiting from a $40,000 tax free capital gain, as well as flipping two purchase agreements resulting in a $20,000 and a $28,000 tax free capital gain respectively.  The rest of the properties in my Roth IRA are generating tax free rental income.

Because of my own experiences investing in real estate with an IRA, I have been able to help a few friends get through the process from start to finish.  In the last couple years I have been able to help some of my clients who I do financial and tax planning for set up their self directed IRAs and purchase their first property within.  Just last month I was paid to review a self directed IRA set up as well as a short term investment plan that involved buying real estate in the IRA.

While I can assist you in “strategizing” and planning, I am not an administrator and cannot administer your self directed IRA. For that you need a credible and reputable professional.  The company I personally use is Guidant Financial.  David Nilssen and his team at Guidant have been an invaluable resource in helping me achieve my investment objectives.  You can read more about their self directed IRA program here.

Concluding Thoughts

If you are interested in buying real estate in IRA, I suggest you spend a lot of time researching the pros and cons involved, as well as the different types of administrators that will support your investment objectives.

I highly recommend that you start putting money in an IRA long before you switch over to a self directed IRA so that you have capital built up to invest in real estate. Starting one from scratch will limit you to the annual cap of $5,000, which changes based on the most current tax code.

Since loans are a nightmare to deal with within an IRA, it would be challenging to purchase property without a good sum already built up. Finally, in my opinion a self directed Roth IRA is the best mechanism for achieving maximum results with real estate investing from within an IRA.

Readers: What do you think of this type of investing? Is it something you are already doing or will consider down the road? Why or why not?  I’d be happy to share with you my contacts in this industry, but please only email me if you are serious.  You can also contact Guidant Financial directly if this is something you are serious about.

Self Directing

Disclaimer: This is not financial or tax advice. Consult paid legal professionals.  See my disclaimer in the footer below. Read more on Wiki about buying real estate in IRA.

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19 Responses to “Buying Real Estate in Your Self Directed Roth IRA to Escape Taxes and Maximize ROI – Pros, Cons and Other Considerations”

  1. jim syyap says:

    A decade ago, investing on real estate was on the top of my list. Thanks to the internet, that has changed. My priority now is to grow my online businesses so that I can live the expat life. Thank you for sharing.

    • Sunil says:

      Jim – I agree with you in many ways. Internet ventures, if established right, can become a solid source of income (passive and residual too to a large extent if one wishes).

      Do you still hold real estate? Interested in hearing about your current plans, as well as near term approach both with regard to RE and web properties???

  2. Gary says:

    Can you buy tax lien certificates within a self-directed IRA? What do you think about that? Thanx!

    • Sunil says:

      Yes you can Gary and I have done it. Most “legitimate” investments are permissible under a self directed plan. I haven’t invested in tax liens recently due to lack of time.

      • Gary says:

        So I’d like to get started in investment properties but have no disposable assets aside from about $50K in a standard IRA. I live where the property prices are still pretty high so don’t think I could buy anything without a loan. What would you recommend for me to get started? Thanx for your help Sunil!

        • Sunil says:


          Unfortunately you cannot withdraw from a trad IRA w/o stiff penalties. The good thing about real estate is it is highly “leverageable”, so you can control a $100k property and are entitled to profits from it with just $20k down, or less in some cases.

          Check the Resources section on the header above and drill down to the real estate section. Those are some of the resources I’ve used that are pretty good.

          All the best

  3. great blog, im thinking of going into buying real estate in Individual Retirement Accounts to maximize my long term return on investments in 2012, am really glad i read this, thanks for your help

  4. Kelly says:

    It is a great time to buy real estate for sure. We expect to sell more Waikiki beach condos even this holiday season!

    • Sunil says:

      Welcome to the blog Kelly. I’ve considered a vacation condo in Waikiki before. Tell me more about the trends / valuations you are seeing? Seeing anything different in today’s purchase patterns relative to 3+ years ago?

  5. Sophia says:

    It is a informative post and thank you. I have little idea about the investing real estate. From your post, it is really a good choice, if have this ability, should try it and prepare for your following life.

  6. Sunil I accede with you when you say buying real estate for individual retirement account as i find it to be really beneficial as long term assest…

    • Sunil says:

      it has been a great way to expedite building tax free wealth for me, especially in these times when property values are depressed and you can use a smaller amount to get in. have you done anything along those lines? what are you involved with John?

  7. Kindergeld says:

    Howdy would you mind letting me know which web host you’re working with? I’ve loaded your blog in 3 different web browsers and I must say this blog loads a lot faster then most. Can you suggest a good web hosting provider at a fair price? Thank you, I appreciate it!

  8. Julian says:

    A contractor license and identification along school bus with an attorney in Manhattan. As a result, the homeowner the perfect matches for all family members.

  9. Peggy says:

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  10. KERA BATISTA says:

    Thought-provoking article . I was enlightened by the insight , Does someone know if I could possibly obtain a template NY MV-410 copy to fill in ?

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