How to Invest in Real Estate With a Self-Directed IRA
A common question from investors looking at private real estate is whether they can use retirement money to do it. For many, the answer is yes, through a self-directed IRA or a Solo 401(k). The mechanics are not complicated, but a few details can trip people up, so it pays to understand them before you start.
What a self-directed IRA is
A standard IRA at a major brokerage typically limits you to stocks, bonds, and funds. A self-directed IRA, or SDIRA, is still an IRA with the same contribution limits and tax treatment, but it is held at a specialized custodian that allows alternative assets, including private real estate, private funds, and notes. The "self-directed" part means you choose the investments. The custodian holds the account and handles the paperwork, but does not advise you on what to buy.
How the process works
The path usually looks like this. You open an account with a self-directed custodian. You fund it, often by transferring or rolling over money from an existing IRA or an old 401(k). When you are ready to invest, you direct the custodian to send funds from your IRA into the investment. The key point is that the IRA invests, not you personally. The asset is owned by the IRA, and any income flows back into the IRA, where it continues to grow on a tax-advantaged basis.
Two tax wrinkles to know
Most income inside an IRA grows without current tax. Private real estate adds two exceptions worth flagging.
The first is UBIT, unrelated business income tax, which can apply to certain types of income earned inside a retirement account. The second is UDFI, unrelated debt-financed income, which can apply when an investment uses a mortgage or other leverage, because part of the return is then attributable to borrowed money rather than your IRA's own capital. Neither is a reason to avoid the strategy, but both can affect your net result, and they are exactly the kind of thing to run past a CPA before you commit.
Mistakes to avoid
The rules around SDIRAs are strict about who can benefit. You cannot use the property personally, and you cannot transact with disqualified persons, which includes you, your spouse, your parents, and your children. Doing so can be treated as a prohibited transaction and can jeopardize the tax status of the entire account. You also need enough cash in the IRA to cover its share of expenses, since you cannot simply pay them out of pocket.
When the investment is a private fund, the IRA receives the tax reporting, typically a Schedule K-1, in the name of the IRA rather than you personally.
Before you move
A self-directed IRA can be a powerful way to put retirement capital into private real estate, but the details matter and they are personal to your situation. Confirm the specifics with your custodian and your tax advisor first. If you are exploring whether a Honeyshares offering can be held in a self-directed account, our team can point you to custodians that handle this regularly. Start on our Invest page.
