SDIRA Buy and Hold Real Estate Guide
The Step-by-Step Process:
- Establish a Self-Directed IRA: This is the first step. Not all custodians allow this. You need a specialized SDIRA custodian (like Equity Trust, Advanta, or others) that handles “alternative assets” like real estate.
- Fund the SDIRA: You transfer or roll over funds from a traditional IRA, 401(k), or other eligible retirement account into your new SDIRA.
- Find the Property: You do all the legwork of finding, analyzing, and negotiating the purchase of the property. The custodian does not give investment advice.
- Execute the Purchase: This is where your initial instructions come in.
- The purchase contract must be titled correctly (e.g., “Equity Trust Company FBO [Your Name] IRA”).
- All funds for the purchase, closing costs, and earnest money deposit must come directly from the SDIRA.
- The title/deed will be recorded in the name of your IRA Trust.
- Manage the Property: As the IRA owns the property, all expenses and income must flow through the IRA.
- Rent: All rental income is paid to the IRA (e.g., “Equity Trust FBO…”) and is deposited directly into the SDIRA. It is tax-deferred (or tax-free for a Roth SDIRA).
- Expenses: All expenses (property taxes, insurance, repairs, HOA fees, etc.) must be paid from the SDIRA. You cannot pay for them out-of-pocket.
The CRITICAL Rules: Prohibited Transactions and Disqualified Persons
This is the most important part. The IRS has strict rules to prevent you from getting a personal benefit from your retirement assets before retirement age. Violating these rules can lead to the entire IRA being disqualified, resulting in massive taxes and penalties.
You cannot use the property for personal use. Ever.
This means:
- You cannot live in the property.
- Your spouse, children, parents, or grandchildren cannot live in it.
- You cannot use it as a vacation home.
You cannot transact with “Disqualified Persons.”
This includes:
- You, the account holder.
- Your lineal ascendants (parents, grandparents) and descendants (children, grandchildren).
- Your spouse.
- Fiduciaries and service providers of the IRA (e.g., your custodian).
- Entities (like an LLC or corporation) owned 50% or more by any of the above.
What does this mean in practice?
- You cannot personally manage the property or do “sweat equity.” You must hire a truly third-party property manager (who is not a disqualified person) to handle tenants, repairs, etc.
- You cannot buy a property from, or sell a property to, a disqualified person.
- You cannot loan money from your IRA to a disqualified person.
Pros and Cons of the Buy-and-Hold Strategy in an SDIRA
Pros:
- Tax-Advantaged Growth: All rental income and appreciation grow tax-deferred (Traditional) or tax-free (Roth).
- Diversification: Moves your retirement portfolio beyond stocks and bonds.
- Control: You have direct control over the investment.
Cons:
- No Personal Use: As detailed above.
- Complicated & Strict: The rules are rigid and easy to violate accidentally.
- Costs: SDIRA custodians have fee schedules (often annual flat fees + transaction fees) that are higher than a standard IRA. You also have the cost of a property manager.
- Liquidity: Real estate is not a liquid asset. If your IRA needs cash, you can’t just sell a few shares; you have to sell the property.
- No Mortgage Deduction: Since the IRA owns the property, you cannot deduct mortgage interest on your personal tax return. (It’s worth noting that buying with an IRA-owned mortgage is possible but very complex and subject to Unrelated Debt Financed Income tax).
Conclusion
Buying and holding real estate in a Self-Directed IRA is not only possible but a popular strategy for savvy investors.
The key is to treat the IRA as a separate, arms-length entity and to be hyper-vigilant about the IRS rules.
Your first and most important step is to work with a knowledgeable SDIRA custodian and a qualified tax professional who specializes in this area to ensure you set everything up correctly and avoid costly mistakes.
