SDIRA Rules Real Estate Investors Should Know

Real estate is the most common alternative asset held in self-directed IRAs, and buying property with retirement funds comes with its own set of rules to understand. The IRS applies specific set of rules to keep the transaction, the income, and the people involved separate from the IRA account. Before an investor puts an offer on a property using a self-directed IRA, it helps to understand exactly what those rules require.

What is a Self-Directed IRA?

A self-directed IRA (SDIRA) is a retirement account that allows investors to hold assets beyond stocks, bonds, and other common investments. It follows the same tax rules as a Traditional or Roth IRA, but when it is administered by a custodian that supports alternative assets, it can hold real estate, real estate notes and other investments.

Why This Matters for Self-Directed IRAs

Investing in real estate personally and buying real estate through an IRA follow very different rules. In a regular investment purchase, the investor can do their own repairs, sign an investment loan, and pocket the rent. None of that applies when the property is purchased using an SDIRA. The property is owned by the IRA, so every dollar that goes into the property, and every dollar that comes out must move back to the IRA.

The investor cannot personally benefit from the property while it sits inside the IRA account. However, there are many benefits as to why an investor may want to use an IRA such as, tax-free growth, no capital gains taxes, and a hands off approach.  

How It Works

At a basic level, something we discussed in our Summer Class, real estate investing through an SDIRA follows a consistent flow:

1. Fund the account. Money moves into the SDIRA through a transfer or rollover from an existing or previous employer retirement account. 
2. Identify the investment. The investor researches and selects a property or real estate-related investment, such as rental property.
3. Identify investment strategy. After selecting a property, the investor decides how to fund it. Options include partnering with other investors, using a non-recourse loan, setting up an LLC, or paying cash.
4. The IRA makes the purchase. Contracts are made in the name of the IRA because title is held in the name of the IRA (or an IRA-owned LLC, if the investor uses a checkbook IRA), not in the investor's personal name.
5. Managing the property. All income the property generates, such as rent, flows back into the IRA. All expenses, including but not limited to, property taxes, insurance, repairs, and management fees, are paid from IRA funds.

If the property is financed rather than purchased outright, the SDIRA typically needs a non-recourse loan.
With this type of loan, the IRA is the borrower rather than the investor, since the investor cannot personally guarantee the debt.

Important Rules and Considerations

Real estate inside an SDIRA is subject to prohibited transaction rules. Violating them can cause the IRS to treat the entire IRA as a distribution, which can trigger taxes and penalties, depending on the account owner’s age.

Here are a few of the rules to review before investing:

• No personal use. The account owner, their spouse, and other disqualified persons cannot live, vacation, or otherwise personally use property owned by the IRA, even for a short stay, and even if they pay fair rent.
• No transactions with disqualified persons. The IRA cannot buy property from or sell property to the account owner or certain family members, including a spouse, parents, grandparents, children, and their spouses.
• No sweat equity. The account owner and other disqualified persons should not personally perform repairs, renovations, or maintenance on IRA-owned property, since it is treated as a prohibited benefit to a disqualified person.
• Income and expenses stay inside the IRA. Rent gets deposited into the IRA, and property-related expenses get paid from the IRA. Mixing personal and IRA funds, even temporarily, is a prohibited transaction.

These rules do not make real estate investing through an SDIRA difficult, but they do require the account owner to treat the IRA as a separate financial entity, apart from their personal finance.

Common Mistakes to Avoid

Some of the most frequent issues investors run into are not complicated in concept, but they are easy to overlook in practice:

• Paying an expense personally. Covering a repair or a tax bill from a personal account, even temporarily, can be treated as a prohibited transaction.
• Letting a family member use the property. Allowing a disqualified person to stay in or use IRA-owned real estate is prohibited.
• Doing the work yourself. Painting, repairing, or managing the property personally instead of hiring a third party can be treated as providing a service to the IRA.
  
  

A prohibited transaction can affect the tax-advantaged status of the entire account, not just the property involved.

How IRAR can help

IRAR can help you open and fund a Self-Directed IRA and handle the paperwork and recordkeeping involved in purchasing, holding, and selling real estate inside the account. This includes processing transactions, tracking income and expenses tied to the investment, and keeping the account's records aligned with what the IRS expects from a retirement account.

If you're ready to look at your options, schedule a free consultation with an IRAR specialist to walk through how the account would work for the type of real estate investment you are considering. IRAR can help you open and fund a Self-Directed IRA, understand the process, and complete the paperwork needed to invest in alternative assets like real estate.