With real estate prices rising over the last several years, a growing number of spouses are looking to figure out a way they can combine their IRA or rollover 401(k) funds to buy real estate together. Lucky for them – the IRS permits family members to use their retirement funds in a joint real estate venture investment.  This article will explore how the Self-Directed IRA rules work and the most common ways to engage in a joint venture real estate investment using IRAs with a spouse or other family member.

What is a Self-Directed IRA?

A Self-Directed IRA is basically a regular IRA that allows its owner to invest in alternative assets, such as real estate. The catch is that your custodian must permit these types of investments. While there are only a handful of investments you cannot make with IRA funds (collectibles, life insurance), it’s up to the custodian to choose which investments it will allow.

The other caveat is that you cannot use your IRA investments to benefit yourself (the IRA owner) or any disqualified person. The investments must solely benefit the IRA itself. For example, you cannot own a vacation property in your IRA and use it for personal reasons. This is considered a prohibited transaction.

Your IRA is Not a Disqualified Person

The Internal Revenue Code (IRC) does not describe what an IRA can invest in, only what it cannot invest in. IRC Sections 408 and 4975 prohibit a “disqualified person” from engaging in certain types of transactions.

The rationale behind these rules was a congressional assumption that certain transactions between certain parties are inherently suspicious and should be disallowed.

The definition of a disqualified person extends into a variety of related party scenarios, but generally includes the IRA holder, any ancestors or lineal descendants of the IRA holder, their spouses, and entities in which they holds a controlling equity or management interest.

Code Section 4975(e)(2) does not list a retirement account as a disqualified person in connection with the application of the IRS prohibited transaction rules. In September 2021, a version of the Build Back Better bill was released that contained a provision that would treat retirement accounts as a disqualified person in relation to the retirement account owner, but the bill was not passed.  Hence, one can use multiple IRAs or 401(k) plans in a joint venture directly or via an LLC without triggering the prohibited transaction rules. In addition, since a retirement account is not deemed a disqualified person under the Code, the joint venture can be between the IRAs of disqualified persons, such as a spouse, child, or parent.

Best Ways to Do Joint Venture Real Estate Using a Self-Directed IRA

In general, there are two ways parties can engage in a joint venture to buy real estate with the use of multiple retirement accounts.

Self-Directed IRA

A full-service Self-Directed IRA offers an investor more investment options than a plan from a typical financial institution. A special IRA custodian, such as IRA Financial Trust, will serve as the custodian of the IRA. Unlike a typical financial institution, most IRA custodians generate fees simply by opening and maintaining IRA accounts and do not offer any financial investment products or platforms. With a full-service Self-Directed IRA, the funds are generally held with the custodian, and at the IRA holder’s sole direction, the custodian will invest the funds on your behalf.

For spouses looking to each use a Self-Directed IRA to do a joint venture real estate deal, title to the real estate would need to include each individual IRA.  For example, if John Doe and Jane Doe each used $100,000 to buy a piece of real estate, title to the real estate would be as follows: IRA Financial Trust Company CFBO John Doe IRA 50% & IRA Financial Trust Company CFBO Jane Doe IRA 50%.

In most cases, the joint venture would establish a bank account to receive any rental income or gains from the real estate asset. The funds would then be allocated to each IRA pro rata. Moreover, it is common in these situations to hire a third-party property management company to handle the day-to-day operations of the real estate as well as the allocation of rental income. However, for real estate joint ventures between IRAs, the Self-Directed IRA LLC is the far more popular option.

The Self-Directed IRA LLC

The Self-Directed IRA LLC with “checkbook control” has quickly become the most popular vehicle for investors looking to make real estate investments that require a high frequency of transactions, such as rental properties. Under the Checkbook IRA format, a limited liability company (LLC) is created which is funded and owned by one or more IRAs and managed by the IRA holder. Each IRA owner of the LLC will own a pro rata percentage of the LLC based on the amount of IRA funds invested in the LLC. This plan offers each IRA owner limited liability protection of any IRA assets outside of the LLC.

In addition, the Checkbook IRA LLC structure makes it much easier and cleaner for a joint venture real estate investment since title to the real estate would be in the name of the LLC. All rental income or gains would flow back to the LLC and can then be distributed tax-free to each IRA member pro rata.

With a Self-Directed IRA LLC, the manager(s) of the LLC can make real estate-related decisions and pay expenses without involving the IRA custodian, which is not the case with a full-service plan. In addition, each IRA investor would have a greater degree of privacy since title to the real estate would be in the name of the LLC rather than in the name of each IRA.

However, the one drawback of using an LLC that will be owned by multiple IRAs, is the an LLC with two or more owners is treated as a partnership for federal income tax purposes and is, thus, required to file IRS Form 1065 even though no tax is due (IRA Financial offers tax filing services for its clients).

Conclusion

With real estate prices growing at a faster rate than many IRA accounts, more and more individuals have looked to co-invest with their spouse or other family members using multiple IRAs. Since an IRA is not treated as a disqualified person, family members can co-mingle IRA funds in a single real estate transaction so long as no personal benefit is being derived from the transaction.

The most popular structure for a real estate joint venture for spouses using multiple IRAs is the Self-Directed IRA LLC.  Using an LLC provides each IRA owner with many benefits, including limited liability protection, privacy, simpler management, easier administration, and greater flexibility.  It is for all these reasons that most joint venture real estate investments involving multiple IRAs use the IRA LLC structure.