How to Use a Self-Directed IRA to Invest in Real Estate (2024)

This is a guest post from my friend Sean McKay of American IRA. Sean and his wife Heather invest in rental properties in Charlotte, NC, and he is also an expert on using a self-directed IRA or 401k to invest in real estate. I’ve used self-directed IRAs for almost 18 years both investing with my own accounts and also borrowing money from the IRAs of private lenders for my real estate deals. So, I’m excited for Sean to share exactly how this works. Take it away Sean!

Podcast Interview With Sean

I have to admit that it is absolutely surreal to have the opportunity to provide content for the Coach Carson blog. I have known Chad since 2009 and I consider him to be a great friend and mentor to my wife and me on our financial journey.

My goal today is to bring fundamental content as well as a genuine investor insight into the topic of Self-Directed IRA’s and 401(k)’s. Self-Directed retirement accounts can be an incredibly useful wealth-building tool when utilized properly. But there are also a tremendous amount of misconceptions.

I hope to bring you a bit of clarity in the article. Here’s a summary of what I’ll cover (feel free to click on a topic you like to skip directly).

• What is a self-directed IRA and 401(K)?
• Contribution Limits and Distributions From Self-Directed IRAs
• Real Estate in your Self-Directed IRA
• Benefits of Using a Self-Directed IRA to Invest in Income Property
• Case Study of Rental Property in a Self-Directed IRA
• Self-Directed IRA Risks and Pitfalls
• The Rules for Investing in Real Estate With a Self-Directed IRA
• Team Members to Help you with your Real Estate IRA Transaction
• What are the Fees For a Self-Directed IRA?
• Frequently Asked Questions (Lightning Round!)

What is a Self-Directed IRA and 401(K)?

Most people think about stocks, bonds, and mutual funds with their IRA or 401(k). Over 90% of retirement accounts consist of those types of investments, so that’s understandable.

A self-directed IRA, on the other hand, just means you have more investment choices for your retirement funds. Which choices you have depends on which financial company you work with.

Popular providers like Vanguard, Schwab, and TD Ameritrade allow you to “self-direct” by picking from traditional investments like index funds and individual stocks. Those providers can be fantastic resources if you are only interested in those types of investments.

But there is also a different tier of “self-direction” where you pick your own investments from a larger pool of investment choices. The self-directed providers in this category, such as our firm, allow you to not only pick your own investments, but also invest in assets such as real estate, debt instruments (private mortgages), privately held companies, and digital assets such as bitcoin.

Contribution Limits and Distributions From Self-Directed IRAs

Self-directed retirement accounts have the exact same rules and regulations to follow as “regular” retirement accounts. For example, you can contribute to the account up to certain limits each year.

Here’s a chart of the current contribution limits for all IRA accounts:

You can also take distributions (i.e. withdraw money) from the self-directed account when the time is right. Up to age 59.5, all withdrawals incur a 10% early withdrawal penalty (plus any applicable income taxes). However, there are some fellow early retirement nerds like the MadFientist who share clever strategies to access retirement money early without penalty.

Also keep in mind that if you currently own a Traditional IRA, Roth IRA, or 401k from a prior employer, you can transfer (i.e. roll over) funds to a self-directed account. And you don’t have to move all of the money from your existing account. You can roll over a portion of the funds to American IRA or another self-directed custodian in order to make real estate investments.

Now, let’s look at how that process works.

Real Estate in your Self-Directed IRA

A self-directed IRA that invests in real estate (aka a “real estate IRA”) is simply an IRA or 401(k) that purchases direct ownership of an investment property. This means that you cannot purchase your primary residence or vacation home with your real estate IRA.

The IRS wants to make sure that you are making true investments with your self-directed retirement accounts. This means you can invest using real estate strategies like:

• Private mortgages (i.e. loans)
• Rental / income properties
• Land
• Tax liens
• Fix and flip properties (i.e. can be quickly resold for a profit)
• Wholesale properties (i.e. flipping to other investors)
• New construction “spec” homes (i.e. it’s built before a buyer is found, a lot like a fix and flip).

There are many profitable and legal ways to use your self-directed IRA account in real estate. My day job at American IRA gives me a front-row seat to some of the most creative investors and dealmakers in the business. By applying their real estate and entrepreneurial skills to a self-directed IRA account, they’ve accumulated significant wealth.

But to give you a fair warning, I have also seen investors lose significant sums of money by making very poor investments. So, it’s smart to learn from those mistakes and from sites like coachcarson.com so that you can avoid losses for yourself.

Now, let’s look at some of the core benefits of one of the more popular self-directed IRA real estate options – investing in rental property.

Benefits of Using a Self-Directed IRA to Invest in Income Property

There are 3 benefits of using a self-directed IRA or 401k to invest in rental or income property:

1. Simplicity of investment
2. Ability to purchase at a discount
3. Quality cash flow

I’ll explain each one of those in more detail.

Benefit #1: Simplicity of Investment

I am a VERY bad stock market investor. I think I’ve made every possible mistake. One of the many challenges I’ve had with stock investing was my inability to understand the financial details of the company that I was investing in. When I look at corporate financial reports, it appears to be in a different, very complicated language!

But the beauty of rental properties is their simplicity. You can often do rental analysis on the back of an envelope or take a simple analysis course like Coach Carson’s to get a good spreadsheet.

There are also many free resources online like Zillow or Redfin to estimate property values. Or you can use a local real estate agent or appraiser to give you their expert opinion of value.

And unlike stocks, residential real estate values are relatively intuitive. If a house down the street of similar size and condition just sold for $200k, it’s safe to say that your property is likely worth a similar value. And the same common-sense rules apply to rental values.

Benefit #2: Ability to Purchase at a Discount

As I’ve observed a lot of highly successful investors over the years, I’ve noticed a pattern. They tend to buy their investment properties at a discount.

The stock market is a very efficient market where it’s difficult to buy a stock below its current value. But discount purchases in real estate are much more common.

Real estate markets are inefficient, meaning the price you can pay doesn’t always reflect it’s true value. There are many reasons this occurs, including fewer buyers competing to buy one house, less extensive information, and the emotional nature of real estate purchases for many sellers and buyers.

For example, the owner of a property may need to sell the house in a week for personal reasons. Or another owner may not want the hassle of fixing up a property and listing it on the open market. And another property may be owned by four siblings who inherited it from their parents and don’t have the desire or money to prepare the home for resale at top value.

These types of situations create never-ending opportunities for you as a self-directed IRA owner to make profitable investments in real estate.

Benefit #3: Quality Cash Flow

Growing up in Florida, I saw dramatic swings in the values of properties. I can still remember condos on the beach that were selling for $150k in 2006 sitting on the market in 2010 for $40k!

So, I completely respect the dangers associated with real estate. Just as children of the 1930’s Great Depression developed a very conservative perspective, I’ve tried to be very cautious with my investments.

But going back to that period when prices fell between 2006 and 20010, what stuck with me was how the rents for the properties did not change. While it’s possible that rents could also drop in some scenarios, they tend to be more stable than prices because they’re tied to the salaries of real working people in the area.

So, we realized that focusing on the cash flow was a way to stay conservative as a real estate investor.My wife and I have certainly been fortunate to ride the wave of appreciation on our rental properties over the last few years. But we have always purchased a property with the expectation that it would not increase in value. Instead, we assumed it would produce a reasonable stream of income from the rents.

We have enjoyed cash returns of 8-10% within our own portfolio. And this strong cash return is one of the big benefits of self-directed IRA investing in real estate compared to index funds and other stocks investments that usually have dividends in the 2-3% range.

Case Study of Rental Property in a Self-Directed IRA

Let’s assume you have your Roth IRA account currently invested in low cost, stock index funds at a place like Vanguard. You’ve decided that passive index funds are a foundation of your retirement wealth-building plan.

First, let me say this is a great idea. I am a strong believer that low-cost index funds are the most efficient and productive way for the majority of us to create wealth.

But let’s say you also decide to diversify your portfolio by purchasing one rental property with a self-directed Roth IRA. You may sleep a bit easier knowing your rental property produces income even as the stock market drops. And when your rental property eats several months of cash flow with a new roof, you can feel good about the consistency and growth of your index fund.

You also know the reality that a rental property requires a larger commitment of time than simply opening an account with Vanguard. In that case, you push a few buttons and almost instantaneously you own a hundred shares of the index fund VTI.

But as I’ve already shared, the benefits can be worth the extra effort. So, here are the steps you take to buy a rental property with your IRA:

Step 1. Create your self-directed account

Now that you have committed to the idea of purchasing a rental property, you identify a self-directed IRA provider. This company will allow you to invest in an alternative asset like a rental property, which cannot be done through traditional companies like Vanguard.

For the sake of this discussion, I am going to daydream that you find our company, American IRA, to be a quality resource. So, you open an account with us.

Our application kits can be found online (link above), or you can reach out to us via phone or email and we can send you the kit directly (see the same link). If you make us aware that you heard about us through Coach Carson, we will be happy to waive your $50 set up fee.

Step 2. Fund your Account

In order to have enough funds to buy a rental property, it is very likely you will be moving over an existing Roth IRA. So once your account is opened, our team then arranges a call with you and your current financial services firm. We are always happy to assist with the paperwork to move over the funds. But you can also personally reach out to a representative or advisor that you have been working with to originate the movement of funds.

Step 3. Making Your Investment

If you have ever purchased a residence or investment property, you can appreciate that it is a multi-step process to close on the house.

So, during this deal you remember that any agreement you make with a property seller (offer to purchase) must have specific verbiage that states your Roth IRA is the buyer who is purchasing the property (and NOT you personally). If that’s confusing, don’t worry because we have instructions and team members that hold your hand throughout this process.

The key with making this investment through your Self-Directed Roth IRA is that your IRA must pay for every element of the investment. This includes:

• any sort of earnest money or due diligence money needed to bind the offer to purchase
• the money needed to close on the property
• any expenses such as property taxes, insurance, and repairs

Anything that an owner typically pays for a rental property, your self-directed IRA account must pay as the owner of the property. This means our company (or your property manager who holds your funds) must pay everything on your behalf.

Step 4: Maintaining and Selling Your Investment

Conversely, any income from renting the property or from selling the property will flow back to your IRA. Many clients choose to have a property manager who works with the tenant, collect rent, and pays for maintenance items. Then the property manager sends allnetfunds to us as the custodian of your IRA.

When you think about it, this arrangement is identical to your current index funds. Each quarter the index fund pays your Roth IRA (and not you personally) dividends. And if you sell shares of the index fund, the money flows right back to your Roth IRA account and not your personal account.

Congratulations! Your IRA now owns a rental property. That wasn’t so bad, was it?

But before we think this is all easy and risk-free, let’s take a look at some of the risks and pitfalls of a self-directe IRA.

Self-Directed IRA Risks and Pitfalls

While I am a huge believer in the wealth-creating potential of investing in real estate with a self-directed IRA, there are a number of factors to consider before making these investments.

1. Lack of Knowledge About Particular Assets

Whether it is the stock market or real estate investing, you can lose money. It’s as simple as that. But this is especially true if you are not committed to becoming knowledgeable about the investments that you are looking to make.

When I lived in Florida, I remember observing that some land continually changed ownership with different investors due to unpaid property taxes. And after doing a bit of digging, I realized that these investors had purchased some good ole fashion swamp land (at cheap prices). The only problem was that you could not build on it and it had no investment value.

I don’t say this to make fun of those individuals. I have made countless bone-headed investments. But their lack of research led them to acquire useless land through a tax sale. Then, they ended up letting go of the property by not paying taxes, which meant that they lost ALL of the money they had invested into the land.

2. Lack of Cash

The older I get, the more I appreciate cash reserves. Rental properties are great, and they make up the lion’s share of my net worth. But you never know when an HVAC unit is going to break. And it’s tough to know when a $10k rehab will balloon into a $15k rehab.

Therefore, it is very critical to make sure that you leave yourself a proper margin of safety so that you don’t get into a cash crunch.

3. Not adhering to the IRS Rules for operating retirement accounts

From time to time self-directed investors can be “overly creative” with their deal structure and run into IRS compliance issues. The motivation is usually an effort to juice their returns.

I’ll cover the actual rules in the next section. For now, I want to make clear that it’s next to impossible for us as your self-directed firm to identify these problems if you try to hide them. We only know the information that you, the client, provide us.

This means that you must show integrity when communicating with your self-directed provider as well as with your tax and legal professionals. This is a critical step if you want to stay compliant with relevant rules.

The Rules for Investing in Real Estate With a Self-Directed IRA

There are two core concepts to become extremely familiar with when making self-directed investments. You want to analyze:

1. Who is involved in the transaction
2. What individuals and companies are providing services

The IRS does not want your IRA or 401(k) to purchase an investment asset from a disqualified person/company or to sell an asset to a disqualified person/company. A disqualified person also can’t receive a benefit or provide services to your retirement account’s investment assets (like a rental property).

Staying within the rules starts by understanding who the disqualified persons and companies are.

Disqualified Persons/Companies

This chart explains the disqualified people or entities who can not do transactions (like loaning, borrowing, or selling) with your self-directed IRA or 401(K) account.

Disqualified Services

You also need to be careful of the services done on behalf of your retirement account’s investments. For example, disqualified persons and companies cannot be the real estate agent or the closing attorney/escrow office for a transaction.

And for many of you in the DIY (do it yourself) crowd, you cannot personally do any work on the property. The IRS sees this as an excess contribution (you’re contributing too much money to your account).

For example, let’s say you put a new roof on the property or install a new kitchen yourself. You can’t do the labor for that roof or kitchen. Your IRA (or property management company) must hire out third party individuals or companies to complete the work.

There are other nuances to these rules, so I suggest continuing to study. But if you learn the main rules above, you can avoid any big problems.

Now let’s look at the team members you would need for a Real Estate IRA transaction.

Team Members to Help you with your Real Estate IRA Transaction

As Coach Carson says, real estate is a team sport. So, here are some of the key team members you’ll need in order to successfully invest in real estate with your self-directed retirement account:

Custodian– You will need a self-directed IRA custodian to hold your IRA. That is the role we play at American IRA, LLC.

Closing Attorney/Escrow Agent/Title Company– You need a reliable, competent closing agent for your real estate transactions. In some states this will be an attorney and in other states it will be a title company.

CPA – In the self-directed world, you need to be in close communication with your tax and legal professionals. They can give you clarity on prohibited transactions, especially if you are engaged in creative deal structures.

Real Estate Agent – It is not mandatory, but many clients work with realtors to purchase or sell a property with their retirement account.

Property Manager– If your IRA owns income property, it is ideal to have a third party property manager. The manager provides a buffer between your IRA and the property, and this protects you from violating the IRS rules discussed above.

Now that you’ve seen examples, understand the rules, and know your team members, you’re probably asking about fees, right?! How much does a self-directed IRA cost?

What are the Fees For a Self-Directed IRA?

Typically, self-directed firms charge an annual fee based on the value of your account or on the number of assets held inside the account. Using the account value model, your annual fee can be as high as $3,000/year. With a per asset model, your annual fee can be $200-300 per year, per asset.

At American IRA, we do our best to cap our fees. This allows investors get to retain as much of their upside as humanly possible. Our annual fee for IRA’s is capped at $285/year. Furthermore, the annual fee does not start on our IRA’s until a client makes their first investment. This means that if your IRA simply owns cash while waiting to invest, the account is free.

For a real estate IRA, our fees are as follows:

• Set Up Fee – $50 Waived if you let us know that you heard about us through Coach Carson
• Annual Fee – $165/year for account values less than $7,500 and $285/year for account balances over $7,500/year
• Transaction Fee – This is the purchase or sale of a property. Single Transaction $95 or unlimited transactions $165/year.
• Outgoing Checks -$10
• Wires -$30

That covers the basics of fees. Now, let’s continue with some frequently asked questions about self-directed IRA’s.

Frequently Asked Questions (Lightning Round!)

Chad was kind enough to give me feedback on some of the most common questions that he gets on the topic of Self-Directed IRA’s. So, here are my answers – lighting round style!

Is a Self-Directed IRA a good idea?

If you are not interested in being an active participant in your wealth creation, a self-directed IRA is not going to be a good fit. You will be far better off with index funds or a financial advisor. Conversely, if you are looking to invest in a particular opportunity, such as a private stock offering that you feel optimistic about or invest in an asset class such as real estate, a self-directed IRA is the cat’s pajamas.

Can you roll a Traditional or Roth IRA into a Self-Directed IRA?

Yes, your underlying account will still be a Roth or Traditional, the self-directed concept simply articulates that you are the decision maker for the account and your able to invest in alternative assets. The functionality of the account is identical.

What is a better investment, REITS or real estate through a self-directed IRA?

REITS can be a useful wealth-building tool, but I believe REITS are inferior to direct ownership of real estate for a few reasons.

First, REIT’s continuously dilute their share count. This means that you own less and less of the underlying assets over time. Second, the dividend yield on REIT’s is usually less than from the direct ownership of a rental property. And third, with direct ownership, you could pay cash for a relatively low-risk single-family house, example. Whereas REITs are typically a highly leveraged portfolio of commercial buildings.

Of course, REITS also provide more diversification. So, there are always tradeoffs.

How much does it cost to set up a self-directed account?

In our case at American IRA, the setup fee is waived if you let us know that you heard about us through Coach Carson.

How much money can you put into a self-directed IRA on an annual basis?

The two most common accounts are Traditional and Roth IRA’s. For individuals under 50 years old, you can contribute up to $6k per year. For individuals over 50, you can contribute up to $7k. In order to make a contribution, you will need to have earned income equivalent to the amount you contribute.

Can a self-Directed IRA take out a mortgage?

Yes an IRA or 401(k) can take out a mortgage. It will need to be a non-recourse loan, which are more difficult to get. Non-recourse means your IRA (or you) can’t guarantee the loan. The property is the only security for the loan. There are also potential tax considerations to discuss if you are planning to use a mortgage in this way.

Conclusion

I hope you found this overview of self-Directed IRA’s and 401(k)’s helpful. This topic is a true passion of mine. And I love learning from investors like yourself and hearing about your successes and lessons learned.

I am extremely grateful to Chad for allowing me share information on this topic. It would be a pleasure to be a resource for anyone in this community moving forward.

Thanks so much for taking the time to read this content. I wish you success on your path to financial freedom whether it involves a self-directed account or not!

Happy Investing!

Thank you Sean for that amazing article! I know it’s going to help a lot of people get started with self-directed retirement investing. If any of you want to schedule a free consultation with American IRA or get their free “Essential Guide to Self-Directed IRAs” just visit coachcarson.com/americanIRA. Be sure to mention Coach Carson to get your $50 set-up fee waived.

For full disclosure, if you open an account with American IRA, LLC I will receive a small affiliate commission (at no extra cost to you). I have been a customer and a friend of the company for a long time and only recommend people I would use myself.

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