Last Updated on February 7, 2020
What is a Self-Directed Individual Retirement Account?
A Self-Directed IRA LLC offers IRA investors the ability to use his or her retirement funds to make almost any type of investment, such as real estate, cryptocurrency, stocks and mutual funds. Rather than investing solely in traditional assets (stocks, bonds, mutual funds), you have the option of investing in both traditional and non-traditional assets.
A list of most popular non-traditional assets (alternative assets) include:
- Residential and commercial real estate
- Tax liens
- Investment funds
- Limited Liability Companies
- Private businesses
The list doesn’t stop there. It offers a glimpse into the diverse assets you can make with your Self-Directed IRA. As you can see, not just real estate investments.
You can make these investments on your own, without custodian consent. This gives you “checkbook control” over your retirement funds, and more freedom over your investment choices.
However, there are some Self-Directed IRA real estate rules you must adhere to. Some of these rules apply to most alternative investments you make with your IRA.
What are Self-Directed IRA Prohibited Transactions?
The basis of the prohibited transaction rules are so IRA investments benefit the retirement account and not the IRA owner. The rules prohibit transactions between the IRA and certain individuals known as “disqualified persons”.
You can find these rules under Internal Revenue Code Section 4975.
The IRS does allow IRA holders to use their Self-Directed IRA LLC to purchase real estate or raw land. Because you’re the manager of the Self-Directed IRA LLC, you can quickly and easily make a real estate investment. You simply write a check from your Self-Directed IRA bank account.
The advantage of real estate investments with your Self-Directed IRA LLC is tax-deferral. All gains are tax-deferred until you take a distribution. If you choose a Roth Self-Directed IRA, then you pay taxes beforehand. In this case, all gains are tax-free when you take a distribution.
Self-Directed IRA Real Estate Rules: Tax-deferral Feature
Let’s take a good look at the real estate rules regarding tax-deferral.
Let’s assume you purchase a piece of property with your Self-Directed IRA LLC for $100,000. Later, you sell the same property for $300,000. The $200,000 of gain appreciation is generally tax-deferred. In other words, you pay at a later date.
However, if you purchase the property using personal funds (non-retirement funds), the gain will be subject to federal income tax and sometimes, state income tax.
You benefit financially by using a Self-Directed IRA LLC for real estate investments.
SDIRA Real Estate Rules
When it comes to using a Self-Directed IRA to purchase real estate, there are a number of rules you must follow to make sure the Real Estate investment does not violate any of the IRS prohibited transaction rules.
1. Funds, Expenses and Financing
- You must pay the deposit and purchase price for the real estate property using Self-Directed IRA LLC funds or funds from a non-disqualified third-party.
- No personal funds or funds from a “disqualified person” can be used
- If you need to make additional funds for improvements or other matters involving the real estate investments, all funds must come from the Self-Directed IRA or, again, from a non “disqualified person”
- Don’t use personal funds for expenses, repairs, or taxes that connect to the Self-Directed IRA LLC real-estate investment. Use retirement funds.
- Remember to keep good records of income and expenses you make from the real estate investment.
- All income, gains or losses from the Self-Directed IRA LLC real estate investment should be allocated to the IRA and be returned to the IRA LLC bank account.
2. Disqualified Persons
- You, IRA holder, or another disqualified person in connection with the real estate investment can’t perform services regarding the use of the Self-Directed IRA LLC. Don’t perform active services.
- Don’t engage in any self-dealing real estate transaction which may involve buying or selling real estate that personally benefits you or a “disqualified person.”
3. Title of Real Estate Investment
- You must title the real estate you purchase in the name of the Self-Directed IRA LLC. For example, if you establish a Self-Directed IRA LLC and the name is LLC ABC, LLC, then you must title the real estate purchase as ABC LLC.
4. Non-recourse Loan
- If you need additional finance for a real estate investment, use a non-recourse loan. This type of loan is one that isn’t personally guaranteed and the lender’s only recourse is against the property – not the borrower.
- Although you can use a non-recourse loan with a Self-Directed IRA when buying real estate, the use of a non-recourse loan would impose a tax pursuant to IRC 514 on a percentage of the income the IRA generates. This is based off a percentage of the debt used in proportion to the amount of cash invested.
If you need to make additional IRA contributions to your self-directed IRA, the contribution make it to the IRA custodian/administrator and then the funds will transfer to the IRA LLC.
Make sure you perform adequate diligence on the property you will be purchasing, especially if it’s in a state you do not live in. Although this isn’t an IRA real estate rule, it’s helpful advice when making real estate investments.
Using a Self-Directed IRA Real Estate is quick and easy, however, there are a number of IRS rules and potential tax issues. You must be aware of them before making the investment.
Get in Touch
Do you have questions regarding the Self-Directed IRA Real Estate rules that we didn’t mention in this article? Contact IRA Financial Group at 800-472-0646. You can also fill out the form and speak with an IRA specialist.