Phase 2 - Real Estate 101 (How to or one big idea)

Invest in Real Estate with a Self-Directed IRA

Tyler Stewert
August 25, 2021
Invest in Real Estate with a Self-Directed IRA

Few investors are aware that the IRS does allow the use of retirement funds to purchase real property. The potential tax benefits of this powerful strategy include tax-deferred income and in the case of a Roth IRA, income that is completely tax-free. It’s a neat solution for real estate investors frustrated with hefty tax payments or the short timeline imposed by a 1031 exchange. And yet, most of the $26 trillion in US retirement assets end up in stocks, mutual funds, and exchange traded funds.

RealCrowd founder Adam Hooper recently discussed this topic with Matt Sorenson, a partner at KKOS Lawyers who specializes in self-directed retirement plan law. A teacher at heart, Sorenson wrote the book on self-directed IRA investing and serves as an instructor for the Retirement Industry Trust Association (RITA).

What is a Self-Directed IRA?

To start, we need to distinguish between a traditional individual retirement account (IRA), where your investment options are restricted to securities such as stocks, bonds, and mutual funds, and a self-directed IRA (SD-IRA), which allows alternative investments like real estate. “The best way to describe an SD-IRA is it’s a retirement account that can invest in any investment allowed by law,” Sorenson says. That’s an important point, because while an SD-IRA allows you (the account holder) to be in charge of all your investment decisions, the account is still in possession of a custodian. An IRA custodian is the financial institution responsible for record keeping and IRS reporting requirements. But it’s up to you to value your investment every year and report an accurate value. It’s also your responsibility to conduct the proper due diligence on the securities and any assets you buy. It’s more work on your part, but well worth the effort if you want to ramp up your retirement savings and include real estate in your portfolio.

Convert Your Retirement Account to a Self-Directed Plan

The two main types of IRA accounts set up by investors are the traditional IRA and Roth IRA. Sorenson highlights that to make either of these types of accounts self-directed, you simply move the funds over to a custodian that allows alternative investments. This applies to SEP IRAs and Simple IRAs as well, which are variations of the traditional IRA, and also to other retirement accounts such as a 401(k) offered by employers and solo 401(k) accounts normally set up by sole proprietors.There is one exception. “You typically can’t roll out of your current employer’s 401(k),” Sorenson points out. However, 401(k) accounts set up by previous employers are fair game. In all cases, the essential ingredient is finding an IRA custodian that allows you to self-direct your investments.Sorenson recommends referrals from other professionals in the area. “Some (custodians) have better expertise in private equity than they do in real estate. Others have a better fee structure for real estate versus private equity or LLCs. So, depending on what you’re looking to do, you may want a different custodian,” he says.

A Self-Directed IRA vs. The 1031 Exchange

One of the better known tax deferral strategies used by real estate investors is the 1031 exchange. This section of the Internal Revenue Code—also known as a like-kind exchange—allows an investment property to be exchanged for another and postponed tax payments on the gain. It has to be a similar property to qualify as ‘like-kind’ and the exchange needs to happen within a specified time frame. “There are no rules like that with a self-directed IRA,” Sorenson says. “With the 1031, investors are forced to buy in a certain time and end up buying a property they don’t want and feel frustrated with their replacement property.”Another challenge is ownership structure. If you want to own units in an LLC—a popular strategy when investing through online marketplaces—1031 exchanges are next to impossible given that you won’t own the property outright. Still, 1031s work quite well when the right replacement property lines up with your sale or you need to free up capital.

To be fair, there are also challenges with SD-IRA investing that can make 1031 exchanges the more appealing tax strategy:

Fees: Investments that use financing must pay UBIT (unrelated business income tax) for that portion of the income derived from indebtedness

Heavily regulated: It is your responsibility to conduct the proper due diligence when selecting an investment that qualifies and abides by the tax rules set forth by the IRS

No “indirect benefits”: All earned income goes back to the SD-IRATaxes: Roth IRAs are hard to beat as profits are 100% tax-free. However, keep in mind that using a traditional IRA simply defers taxes to retirement—at an ordinary tax rate which may be higher than the capital gains rate

Cannot claim depreciation: The IRS sees the IRA as a distinct entity from the holder


Converting your retirement account to an SD-IRA allows more control and the ability to invest in alternative assets. Coupled with the distinct tax advantages, it can be a powerful strategy for the savvy investor. Before taking the plunge, seek professional counsel to understand the risks and challenges involved and make sure you find a custodian that fits with your personal investment goals.


Tyler Stewart is VP of Investor Relations at RealCrowd. All opinions expressed by Tyler and interviewees are solely their own opinions and do not reflect the opinion of RealCrowd. This article is for informational purposes only and should not be relied upon as a basis for investment decisions.

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