Investing Retirement Planning IRAs How to Invest in Real Estate With a Self-Directed IRA Should You Buy Real Estate in an IRA? By Scott Spann Updated on April 6, 2022 Reviewed by Andy Smith In This Article View All In This Article What Is a Self-Directed IRA? Buying Real Estate With Your IRA Benefits of Real Estate in an IRA What Are the Potential Downsides and Risks? What Are SD-IRA Tax Pitfalls to Avoid? Frequently Asked Questions (FAQs) Photo: The Balance / Brianna Gilmartin Most retirement accounts are made of a mix of investments, which can include stocks, bonds, mutual funds, ETFs, and CDs within an Individual Retirement Account (IRA). A growing number of retirement savers, though, are choosing less-common investments. Self-directed IRAs (SD-IRAs) allow you to invest in real estate, precious metals, notes, tax lien certificates, private placements, and many more investment options. But these aren't always the best choices for your retirement savings. Learn some important things to be aware of when using an IRA to purchase real estate. What Is a Self-Directed IRA? A self-directed IRA is a traditional IRA or Roth IRA in which the custodian allows a wide range of investments. One of these options is real estate investments. Investing in real estate appeals to many people who want to use a self-directed IRA to purchase rental properties. An IRA custodian is the financial institution responsible for record-keeping and IRS reporting. For a self-directed IRA, you must accurately value your investment and report the value to your IRA custodian each year. Buying Real Estate With a Self-Directed IRA To buy real estate with a self-directed IRA, you first need to set up an account. Many companies allow you to set up an SD-IRA on your own, but these accounts can be complex. It is helpful to have a custodian who can provide guidance as you work your way through the IRS tax code. Because real estate investments create more of a burden on the custodian, many do not offer real estate as an investment option for IRAs. However, the Internal Revenue Service (IRS) does allow plans to offer real estate as an option for IRA investments. Some IRA custodians have more involved fee structures than others. You'll need to do your research and examine all of the fees and expenses that will impact the full return on your investment. Note You may need to establish a limited liability company (LLC) to hold your SD-IRA assets. A custodian or tax advisor can help you decide whether this is the right choice for you. With self-directed IRAs, you must produce enough cash flow to cover all potential home improvement and repair costs without the need to add cash each year. What Are the Benefits of Owning Real Estate in an IRA? Using a self-directed IRA to buy real estate comes with the potential for tax benefits. As is the case with any holding in your IRA, the income that goes into your IRA is not taxed until you take withdrawals. If you have a Roth IRA, you pay tax on your income as usual. Then, your investment gains will grow tax-free and can be withdrawn tax-free, as well. Note You still must wait until you reach age 59 1/2 to withdraw your funds. If you remove them early, you may be subject to a penalty. That withdrawal will be included as regular income on your tax return. If you are an active investor, though, you can buy, sell, or flip real estate without losing the tax-deferred status of your SD-IRA. You can also move funds from one project to another. A second reason to own real estate in an IRA is familiarity. Local real estate appeals to many investors, and you may prefer to stick with it in times of economic uncertainty. SD-IRAs allow you to put your funds in assets that you know and trust, too. What Are the Potential Downsides and Risks? When you hold a self-directed IRA, you are responsible for staying up to speed on the property itself. This may appeal to you if you have past experience as a real estate investor or flipper. However, if you are not a savvy real estate investor, it could easily lead to unwise or risky choices. And in the case of fraud, you may be more of a target than more experienced investors. Warning The Securities and Exchange Commission (SEC) has an investor alert addressing self-directed IRAs and the risk of fraud. One of the biggest risks of owning real estate in an SD-IRA is a lack of diversification. If you don't have enough cash to own a range of properties, you can't create a diverse real estate investment portfolio. Liquidity is another big concern when holding real estate in your IRA. When your cash is tied up in real estate, it can be hard to access. That may prevent you from taking distributions if you need money quickly. What Are SD-IRA Tax Pitfalls to Avoid? Owning real estate in an IRA allows you to defer paying taxes on the income you invest. Roth IRAs provide the potential for tax-free growth, but if you don’t follow the rules, you could purchase a property the wrong way. That could disqualify the IRA and create a taxable event. Owning real estate in your IRA also means that you lose some of the tax breaks that most real estate investors can take if the property operates at a loss. You also can't claim depreciation on IRA-owned real estate. If you plan to use your IRA to purchase a second home or a primary residence, think again. The real estate you buy with your SD-IRA must all be arm's length transactions. That means you can't make any self-dealing or personal transactions. The rule also applies to your immediate family. If you buy or sell a property to a family member (or yourself), it won't be tax-free or tax-deferred anymore. Unrelated business income tax (UBIT) is another tax issue you could run into. You'll need to be aware of this tax if you are thinking about using a mortgage to buy a property. With a traditional IRA, you must take required minimum distributions (RMDs) once you reach age 70 1/2. However, due to changes made by the SECURE Act, if your 70th birthday is July 1, 2019, or later, you do not have to take withdrawals until you reach age 72. But if you own real estate in an IRA, it's hard to sell off your real estate holdings in small chunks each year. For that reason, you must keep enough cash in your IRA accounts to cover your RMDs. If you don't have the cash you need, you might run into tax problems. Frequently Asked Questions (FAQs) How do mortgage tax breaks work with IRA-owned real estate? Any mortgage tax breaks that you would normally qualify for will be lost when you purchase real estate with an IRA. IRAs are already tax shelter accounts, so you will lose out on any other tax benefits when you choose to use an IRA. If you want to take full advantage of tax benefits, then you shouldn't use your IRA for the transaction. What companies help you use your IRA to buy real estate? Some companies may be more likely to help you set up an SD-IRA than others. If you have an IRA with a brokerage like Fidelity or TD Ameritrade, for example, then the brokerage would likely prefer for you to use mutual funds, ETFs, or stocks to invest in real estate. Companies that offer SD-IRAs for real estate investments likely specialize in that service, so they will make that a prominent part of their promotional materials. If a company doesn't specifically mention SD-IRAs and real estate investments as you're doing your research, you probably need to find another company for your SD-IRA. Was this page helpful? Thanks for your feedback! Tell us why! Other Submit Sources The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy. Internal Revenue Service. "IRS FAQs - Investments." Internal Revenue Service. "Retirement Topics - Prohibited Transactions." Internal Revenue Service. "Retirement Topics - Required Minimum Distributions (RMDs)." IRS. "Retirement Topics — Required Minimum Distributions (RMDs)."