There are a couple of ways to use an IRA to invest in real estate. First, you can invest in mutual funds, exchange-traded funds (ETFs), or real-estate investment trusts (REITs) that focus on real estate investments within an IRA.
It’s also possible to set up a self-directed IRA, or SDIRA, that can own physical real estate, as well as other types of alternative investments.
Using an IRA to invest in real estate property directly, however, is a complicated and potentially risky proposition. It’s important to understand the many rules and restrictions, as well as the potential advantages and disadvantages of investing in real estate in an IRA before doing so.
Key Points
• It’s possible to invest in real estate in an IRA via conventional methods, such as buying shares of a mutual fund, ETF, or REIT.
• Direct ownership of physical property using an IRA means setting up a self-directed IRA, or SDIRA, which requires a specialized custodian, not an ordinary broker.
• While a SDIRA gives investors the ability to invest in alternative investments (such as real estate, commodities, and precious metals), the account holder must oversee and manage the account and all investments.
• Investing in real estate in an IRA comes with stringent rules, including that neither the investor nor anyone in their family can own or live in the property.
• Investors considering investing in real estate through a SDIRA should weigh their risk tolerance, overall portfolio allocation, and the potential time commitment involved.
Can You Invest in Real Estate Using an IRA?
IRAs can offer a wide variety of investment opportunities, including those that target the real estate sector. While conventional investment options within an IRA are often confined to equity and fixed-income mutual funds, exchange-traded funds (ETFs), and index funds, it is in fact possible to use an IRA to invest in real estate in various ways.
Investing in real estate may be appealing to some investors because this asset class tends not to move in sync with traditional stock and bond markets; thus real estate may provide portfolio diversification. Some real estate investments also offer the potential for passive income.
But real estate is a type of alternative investment, and as such tends not to be very liquid, which may present risks for some investors.
Ways to Invest in Real Estate With an IRA
Here are some choices investors can consider for IRA real-estate investments. But not all types of real estate can be held in any type of IRA:
• Real estate mutual funds, real estate-focused exchange-traded funds (ETFs), real estate investment trusts (REITs) are typically available through a traditional, Roth, SEP, or SIMPLE IRA.
• Investing directly or owning residential and commercial investment properties, tax-lien certificates, crowdfunded real estate investments typically require a self-directed IRA or SDIRA (see detail below).
1. Real Estate-Related Funds
Like any type of mutual fund, real estate funds hold a basket of investments. Real estate mutual funds tend to be actively managed funds that may hold shares of real estate-related stocks, REITs, or they may track an index.
A real estate index fund, for example, seeks to mimic the performance of a market benchmark or index.
ETFs, meanwhile, are pooled investments similar to mutual funds, but are traded on an exchange like stocks, so they offer more liquidity. ETFs may also hold real-estate related investments — typically shares of REITs.
💡 Quick Tip: Did you know that you must choose the investments in your IRA? Once you open a new IRA online and start saving, you get to decide which mutual funds, ETFs, or other investments you want — it’s totally up to you.
2. Real Estate Investment Trusts
Investors can also invest in Real estate investment trusts (REITs) directly. REITs own and manage properties on behalf of investors. REITs can target a specific niche or segment of the real estate market, such as retail shopping centers or storage facilities. Or they might hold a wide mix of property investments, including residential rental properties, office buildings, and industrial warehouses.
Dividends are often at the top of the list of benefits when weighing the pros and cons of REITs. They’re required to pay out 90% of profits to shareholders as dividends, making them a potentially reliable source of passive income.
Some of the advantages of REITs include passive income from dividends, and portfolio diversification, but these vehicles come with a number of risks. Potential risks include less liquidity and sensitivity to interest rates, as well as other factors that can negatively impact real estate markets: i.e., consumer trends, property destruction (from wear and tear, or weather), local laws and regulations.
💡 Quick Tip: Before opening any investment account, consider what level of risk you are comfortable with. If you’re not sure, start with more conservative investments, and then adjust your portfolio as you learn more.
3. Investment Properties
It’s also possible to own investment properties directly, such as commercial and residential real estate, among other types of properties. Investment properties can generate passive income through rent payments, and they may offer a profit when sold.
But investment properties typically require an upfront investment of capital, managing a mortgage, and ongoing maintenance that may be beyond the reach of most investors.
4. Tax-Lien Certificates
Tax-lien certificate investing involves buying liens that have been placed against properties in connection with unpaid tax debts. The holder of the certificate can collect interest while the property owner repays the debt. If the owner defaults on the debt, the certificate holder can take ownership of the property.
These are high-risk instruments, typically owing to the potential for losing money on tax payments and low-quality properties that don’t yield a profit.
5. Real Estate Crowdfunding
Real estate crowdfunding platforms, also known as online real estate platforms, allow a number of investors to purchase property by pooling their investment funds. Depending on which platform you’re using, the minimum investment could be as low as $500, but terms vary and the risks can be high.
Crowdfunding is even less liquid than many other types of real estate investments, since there’s typically a minimum holding period — which means investors’ money can be tied up for long periods, and there is no guarantee that a certain property or properties will turn a profit.
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What IRAs Can You Use to Invest in Real Estate?
If you’re interested in real estate funds or REITs, you may be able to invest in these through a traditional, Roth, SEP, or SIMPLE IRA. Many brokerages include real estate funds and REITs as investment options for ordinary IRA investors.
On the other hand, if you’re specifically interested in property investments or tax-lien certificates — i.e., directly investing your IRA in real estate — you’ll need to open a self-directed IRA (SDIRA) instead.
What Is a Self-Directed IRA?
A self-directed IRA is a traditional or Roth IRA that’s held by a specialized custodian that allows investors access to a broader range of investments, including alternative investments like real estate.
Unlike ordinary IRAs which are overseen by a broker, all assets in a SDIRA are researched and managed by the account holder.
Self-directed IRAs are subject to a number of IRS restrictions. Many of these rules also apply to ordinary IRAs, but it’s important to bear them in mind when thinking about investing your IRA in real estate. Specifically, you’re barred from:
• Transacting with disqualified persons. These include your spouse and any family members, as well as your IRA beneficiary if they don’t fit either of those categories. The prohibition also extends to any business entity that’s owned by a disqualified person.
• Using the IRA or investments in the IRA for personal benefit. Using an IRA for personal benefit in any way is not allowed. For example, if you’re collecting rental income from a property you own in the IRA, you have to deposit any profit into the IRA, along with any other income generated by self-directed IRA assets.
• Making disallowed investments. Finally, there are some limits on what you can own in a self-directed IRA. Disallowed investments include life insurance, collectibles, and business interests in S-corporations. Transactions that count as “self-dealing” are also prohibited: i.e., borrowing money from a SDIRA, selling property to it, using it as loan collateral.
Note: While the IRS permits using an IRA to buy a first home, that doesn’t apply to self-directed IRAs.
Steps to Buying Real Estate With an IRA
If you’d like to invest in property or tax lien certificates with an IRA, you need to set up a self-directed IRA, and then purchase the property or similar investment through the SDIRA . Because it can be very difficult to secure a mortgage for this kind of purchase, most direct property purchases are paid for with cash from the SDIRA.
1. Find a Custodian
The first thing you’ll need to do is find a qualified custodian that offers self-directed IRAs for real estate investment. When researching custodians, it’s a good idea to consider their reputation in the space, customer service and satisfaction, as well as the fees you’ll pay.
2. Open a Self-Directed IRA
Once you select a custodian, you can open your SDIRA. Your custodian should be able to guide you through this process, which usually involves completing the appropriate paperwork.
Remember, you’ll need to specify whether you’d like to open a traditional or Roth self-directed IRA. Traditional IRAs allow for tax-deductible contributions, while Roth SDIRAs can offer qualified withdrawals tax free in retirement.
Your custodian may give you the option (or require you) to establish a self-directed IRA as a limited liability company (LLC). Doing so can offer an advantage, since it allows you to have full control with regard to signing authority over IRA funds.
However, setting up an LLC real estate IRA can trigger additional IRS rules against prohibited transactions.
3. Deposit Funds to Your IRA
The next step is transferring funds into your self-directed IRA. That may be as simple as scheduling an electronic transfer from a bank account. You can also roll funds over from a 401(k) or another eligible plan.
Keep in mind that self-directed IRAs follow the same annual contribution limits as other IRAs, but those limits do not apply to IRA rollovers.
4. Compare Investment Options
Once you have money in your self-directed IRA, you’ll need to decide how you want to invest it. If you’re focused on real estate, that might mean purchasing an investment property. It’s important to perform due diligence to find a property that aligns with your investment needs, goals, and risk tolerance.
Remember that self-directed IRA investment options can include:
• Single-family or multifamily homes
• Commercial and rental properties
• Land
• Tax liens
• Mortgage notes
Each one can have a different risk/reward profile so it’s important to understand what you might gain from each one and what you may stand to lose. It’s also a good idea to consider how much of your self-directed IRA funds, and your portfolio as a whole, you’d like to allocate to real estate.
5. Purchase a Property
If you’re investing in a rental property and you’ve found one you want to buy, the final step is making the purchase. You’ll need to make an offer and once that’s accepted, you’ll need to authorize your IRA custodian to complete the transaction on your behalf. That’s important, as the property needs to be held in contract by the IRA, rather than yourself.
Pros and Cons of Investing Your IRA in Real Estate
Investing an IRA in real estate can yield some advantages but there are some serious considerations to keep in mind.
While you can use a self-directed IRA to hold real estate, which may offer some tax advantages, it’s important to know the rules so you don’t risk losing those benefits. Also, keep in mind that holding real estate inside a self-directed IRA can mean missing out on some tax advantages you’d get by owning property directly.
A self-directed IRA can offer high return potential but that means doing your homework first to find solid investments. You’ll need to spend some time researching properties to ensure that you understand the risks, as well as the level of returns you might be able to expect.
Managing a self-directed IRA may be more time-consuming than investing in a regular IRA, especially if you’re not hiring a property manager to oversee property investments. Self-directed IRAs offer less liquidity and depending on which custodian you choose, the fees may be high.
thumb_upPros:
• Potentially for returns
• IRA-related tax benefits
• Diversification
• IRAs are protected from creditors
thumb_downCons:
• Physical real estate is subject to numerous risks
• Stringent rules and requirements
• Less liquid than other investments
• Time-consuming to set up and manage
• Fees may be high
Is Investing Your IRA in Real Estate Right for You?
Deciding whether to invest in real estate with your IRA can start with reviewing your portfolio as a whole. Here are some questions to consider:
• Do you already own any real estate investments, including REITs or index funds?
• If so, how much of your portfolio is allocated to real estate?
• How much time and effort do you have to put into managing real estate investments?
• How much money are you able to invest?
• Do you have a trusted custodian and if not, do you know where to find one?
• What degree of risk are you willing to take and what kind of returns are you hoping to earn?
• Asking those kinds of questions can help you to evaluate where real estate fits into your investment plans and whether a self-directed IRA is the best option for you.
Alternative IRA Investment Options
In addition to real estate, you can also hold a wide variety of other alternative investments in a SDIRA.
• Commodities
• Gold and other precious metals
• Limited partnerships
• Private equity
Remember that the IRS bars you from owning things like artwork, antiques, rare coins or stamps, and fine wine in a self-directed IRA.
The Takeaway
Opening an IRA for real estate investing could be worth the effort if you’re hoping to diversify your portfolio beyond stocks and bonds, but it requires opening a specific type of IRA called a self-directed IRA, or SDIRA. This type of IRA isn’t available from a traditional broker, because you can use a SDIRA to hold alternative investments, such as real estate and commodities.
Ready to invest for your retirement? It’s easy to get started when you open a traditional or Roth IRA with SoFi. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).
FAQ
Can I invest in real estate using my IRA?
You can invest in real estate using a self-directed IRA, or SDIRA. This type of IRA is held by a custodian and allows you to choose from a wider range of investment options than regular IRAs. With a self-directed IRA, you can own rental properties, mortgage notes, and tax lien certificates.
How is real estate taxed in an IRA?
Real estate held in an IRA is subject to the tax rules that apply to the type of IRA. For example, if you have real estate in a traditional SDIRA then any earnings or income generated by those investments would grow tax-deferred. You’d pay ordinary income tax on them when you make qualified withdrawals in retirement. A Roth-style SDIRA would provide tax-free income on qualified withdrawals. Owing to the complexity of self-directed IRAs to begin with, it might make sense to consult a professional regarding tax implications.
What type of real estate can be held in an IRA?
A self-directed IRA can hold residential rental properties, commercial real estate investment properties, tax lien certificates, and mortgage notes. If you have a regular traditional or Roth IRA, you can use it to invest in real estate funds, ETFs, or REITs.
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