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Beginner's Guide: Purchasing a Rental Property With a Self-Directed IRA

Beginner's Guide: Purchasing a Rental Property With a Self-Directed IRA

Estimated reading time: 4.5 minutes

What is a Self-Directed IRA?

 A Self-Directed IRA (SDIRA) is an individual retirement account over which you have complete control. Unlike other IRAs, you’re not limited to stocks, bonds, or mutual funds. A Self-Directed IRA gives you the opportunity to build a truly diversified, more resilient portfolio, and take advantage of alternative assets such as real estate, private equity, and precious metals.

You can transfer or rollover the funds in an existing Traditional or Roth IRA into a Self-Directed IRA without penalties or needing to sell any of your current assets. You can also transfer funds from a dormant 401(k) account into a self-directed account easily.

Individual retirement accounts offer tax advantages that can help your retirement dreams become a reality.

Top Benefits of a Self-Directed IRA

Increased Potential for Growth

Opening a self-directed retirement account gives you the freedom to invest in almost any type of asset—you will have more flexibility in the amount of risk you take on, and a potentially higher rate of return.

Control Over Your Financial Future

Put your industry knowledge and/or niche expertise to good use. Make investment decisions based on what you know and understand to grow your retirement savings.

Protection Against Economic Fluctuation

Diversifying your portfolio by investing in alternative assets can act as a hedge against market fluctuations and volatility.

Grow Savings in a Tax-Advantaged Account

Investing in a Self-Directed IRA that allows for tax-deferred or tax-free growth over time can have a significant, positive effect on future wealth. Investing in assets like real estate with your Self-Directed IRA isn’t that different from making a regular real estate purchase. However, there are rules you must follow to do it correctly.

Self-Directed IRAs that focus on real estate investments are often referred to as Real Estate IRAs. You can use them to invest your retirement funds in real estate assets such as single family homes, multi-family residences, commercial property, mortgage notes, raw land, and nearly any other real asset you can think of.

A Look at the Real Estate IRA Purchase Process

This is a case study about a Self-Directed IRA holder, Maria. She’s interested in using the funds in her Self-Directed IRA to purchase real estate. 

Maria has $250,000 in a Roth IRA at a bank. For some time, her real estate agent, Bob, has been telling her about the benefits of owning real estate in a Self-Directed IRA. She’s intrigued, but the bank serving as her IRA custodian doesn’t allow real estate investments, and she isn’t familiar with the investment process.

Getting Started

Maria starts by reading the materials on a Self-Directed IRA custodian’s website and learning about the IRS rules she must follow. She also reads about prohibited transactions and how to do due diligence on a potential transaction.

Maria decides to open a self-directed Roth IRA. She opens an account online and initiates a transfer to move her IRA balance from her current custodian to the SDIRA custodian.

While the funds are transferring, Maria and Bob look at several potential properties for her IRA investment. One property, for sale at $179,500, fits her budget.

 Maria is Ready to Invest

Once Maria’s funds are available in her new SDIRA, she’s ready to invest. Maria has selected a property, and can fund the purchase several ways: direct purchase, partnering, leveraging, or through a limited liability partnership. Maria chooses to make an all-cash offer (direct purchase), contingent on inspections and clearances. The offer is made and titled in the name of her IRA.

The offer is accepted, and Bob chooses a title company to open escrow. Maria initiates the purchase online, instructing her SDIRA custodian to wire $10,000 to the title company as an earnest money deposit, and an additional $500 for the inspection and other expenses.

Maria reads and approves all documents that Bob, and the title company send to her to ensure everything is correct. Only then does the SDIRA custodian sign the documents on behalf of her IRA. 

Closing Escrow

The property has passed all the inspections to Maria’s satisfaction. She’s ready to conclude the purchase. Once the SDIRA custodian receives all the required documentation, the custodian wires $169,500 from her account to escrow in accordance with the closing statement, which includes all closing costs.

Maria’s IRA now owns the property.

 Rental Income, Expenses and the Road Ahead

After interviewing potential tenants, she selects one, and they come to terms on a rental agreement. The rental agreement is signed by the SDIRA custodian on behalf of Maria’s IRA. Future rental payments are made payable to Maria’s SDIRA account. In the same way, all incurred expenses must be paid out of the IRA.

Maria watches her Real Estate IRA grow as the rent checks keep coming in. The best part is the taxes on the earnings will be tax-free once her Roth account is at least five years old and she satisfies one of the few criteria the IRS dictates. Eventually, Maria has enough profit to purchase a second property with her IRA. She’s always on the lookout for deals that will help her invest in her retirement.

Self-Directed IRAs can be a rewarding way to build wealth. Retirement is about the pursuit of lifelong passions. Making the right investments in unique people, deals, and companies can be a very fulfilling part of the process. Retirement can be a dream come true when investors use Self-Directed IRAs to invest in the projects and people they care about.

Want to learn more about Self-Directed IRAs and real estate? Download our 5 Steps to Investing in Real Estate report.

Self-Directed IRAs:
The Basics Guide

Learn about your investment options, Self-Directed IRA rules, and much more!

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