Buy Real Estate Inside Your Retirement Account
Use your retirement funds to build long-term property wealth without triggering costly penalties.
Did you know your IRA, Roth, 401 (k), or even HSA can buy real estate?
Today I’m going to desceibe you through how to legally and profitably buy real estate inside your retirement account, the rules you must follow, and the exact steps to make sure you don’t trigger taxes or penalties.
This is one of the most misunderstood strategies out there, and when done correctly, it can dramatically change your retirement account value.
Not a REIT, not just real estate stock, but actual rental property. And yet, every week I hear business owners and investors say, “I was told I can’t do that. My broker or investment advisor said that was illegal.”
Well, it’s not that you can’t do it, it’s that they can’t do it. And it’s simply not true.
Now, quickly, let’s hit a few points before we get into the how.
Your IRA, Roth, 401 (k), or HSA can own real estate.
This surprises many people, but the IRS has always allowed retirement accounts to own real estate.
The law does not restrict your IRA to just stocks, bonds, and mutual funds or ETFs. Those limitations come from brokerages, not the tax code.
Because, see, they don’t get a commission when you go out and buy real estate.
They want to manage a brokerage account, but when you go to buy alternative assets, their brokerage may not function to provide a commission for their advisers.
But when you self-direct your account with a self-directed custodian or trust company, you’re simply choosing investments that Wall Street doesn’t sell.
If someone says you can’t, what they’re really saying is they can’t help you do it.
Why do investors want to invest in real estate inside their retirement accounts?
The reason is simple. They make more money. They don’t want to be stuck to just a 7, 8, 9, or even 10% return, if they’re lucky, on a mutual fund or an ETF.
They want to invest in what they know. They want to invest in real estate developments, short-term rentals, long-term rentals, commercial rentals, and real estate that they understand and can oftentimes have an ROI of 15%, 20%, 25% or more.
They want to get the biggest return in their retirement account, and self-directing allows them to do it.
See, the bottom line is, if you already invest in real estate personally and you understand it, it often makes more sense to let your retirement account do the same thing.
Now, it doesn’t mean you don’t invest in Wall Street products as well, but why not do both?
Now, one more point before we get into the how, and that’s deciding on what type of real estate you want to invest in inside your retirement account.
So, make sure you’re intentional, that you really know what you want to invest in before you just start moving money over to self-direct.
Do you like long-term rentals, short-term rentals, raw land, commercial property, even development or storage units? Invest in what you know.
If you’re a farmer, maybe you even invest in farmland.
There is no best type of real estate for inside a retirement account. It’s, again, what you know best.
Now, the real question is how to do this.
Well, the first thing you have to do is open a self-directed retirement account.
Now, this will typically be at a trust company like Directed IRA Trust Company, of which I’m a principal and on the board of directors. But this is a company that allows you to self-direct your retirement account.
You would roll over your IRA or 401 (k) into a self-directed account. And on day two, we call you up and say, “What do you want to invest in?”
I’m going to talk more about that process, but this account is the key to unlocking this entire process.
To buy real estate, your funds must be held with one of these custodians or trust companies. Merrill Lynch or Fidelity is not going to allow for this.
But when you transfer that money over, there’s no penalty. There’s no tax.
Remember, you are not taking money out of your retirement account.
You’re simply moving your retirement account to a brokerage, if you will, or a custodian or trust company that allows you to self-direct.
Maybe another way to say it is you’re not cashing out your IRA, your Roth, or your 401 (k) from an old job.
You’re simply upgrading the investments inside of it by allowing for different types of alternative assets.
- But let’s move on to the next point. We’ve got to fund the account next.
So, we’ve got to get money into this account.
So, if you have an IRA over here with 50 grand in it, you’re going to open an IRA account and transfer that money.
If you have a Roth account, you’re going to open a Roth account. It’s going to be account type for account type. And you’re going to move that money over, sending a direction letter to your current custodian or brokerage account to move the money over to the trust account you just set up.
And you also have to remember it’s going to take a little time. Sometimes it could be done in a few days, sometimes it’s going to take a couple of weeks, depending on how cooperative your brokerage wants to be.
But once you have the account open, it’s just about moving the money over.
And again, remember, there’s no penalty or tax. You’re just moving the money over to another bucket that gives you more freedom.
- Now, once you’ve funded the account, the next step is to create an LLC.
Now, this is a special type of LLC. You can’t just open this up on legals.com. It’s going to have special rules that allow for an IRA or a retirement account to be an owner.
These LLCs are going to give you a lot of flexibility. You get to serve as the manager of this LLC.
You’re going to be able to use that LLC to create faster transactions and clearer asset separation between you and the retirement account.
It even protects you as the manager from maybe some decisions that don’t go so well.
The LLC is giving you asset protection and will be holding your retirement funds when we move that money over.
The LLC will be holding the rental property or real estate.
Now, the LLC must follow strict rules, and you’re going to be the manager, but you cannot pay yourself as the manager of this LLC.
We’re not setting up this LLC or this retirement plan project with your rental property so that you can get a job or get paid for your services.
This is an arm’s-length transaction between your retirement account and you, two different parties.
The retirement account is going to form an LLC to buy real estate.
Now, some of you may go, “Well, hold it. That’s where I make money. I want to make money doing this.”
No, no, no. Remember, we’re trying to make money for your retirement account.
And even if you pay a property manager, your retirement account’s going to have a much bigger return than just a plain old ETF or mutual fund.
So, be patient and know that you might have some extra costs. You can’t put in sweat equity, but, oh my gosh, it pays off over and over again.
So now that you’ve funded the account and formed the LLC, it’s time to fund the LLC with that retirement account.
So, that LLC is going to have its own bank account. You’re going to open that bank account and have the IRA or 401k, Roth, whatever you’ve got, move the amount of money into that LLC.
This is, again, kind of a funding letter or direction letter to the trust company to say, “I’ve decided what I want to do. I want you to fund this LLC. Then the LLC can go out and do business.”
Now, some people, after they’ve decided how much money they want to move over to their IRA, have a second decision of, well, how much do I want to put in this LLC?
Maybe I want to form an LLC for long-term rentals and an LLC for short-term rentals.
And you’ve got a lot of money to play with. You’re fortunate.
But a lot of people are going to move that IRA money in its entirety into the LLC and start buying real estate.
And they want to be thinking about what the purchase price is going to be, how much I need in reserves, what I am going to do for rehab or furnishing, and ongoing expenses.
Because remember, you can’t put more money in yourself. This isn’t your rental property. This is your IRA’s rental property.
You want to make sure you have a cushion in that retirement account or the funded LLC to manage this rental property as it moves forward.
- So, now that you’ve got the money in the LLC, we are ready to buy some property.
And this is going to be a typical situation, like any acquisition for real estate.
You’ve already decided what type of real estate you want to buy. You’ve got your money set aside for it.
You’re going to act as the manager of that LLC and go write offers, go do your due diligence, head towards closing, close on the property, and then hire your property manager, vendors, or contractors to carry out the project, whatever it may be.
Now, I want to transition to a topic called prohibited transactions because, again, you can’t benefit from these transactions or the property. We’re trying to help just the IRA benefit from the project.
For example:
- You can’t be the realtor on that acquisition.
- Your spouse cannot be the realtor.
- Your kids cannot be the realtor.
- Your parents cannot be the realtor.
And that goes for being the property manager or staying in the property.
These are called prohibited parties.
And this is the biggest concept to understand.
These parties, you, your spouse, your kids, their spouses, or your parents and their spouses, are prohibited parties.
Frankly, the IRS doesn’t trust you.
They’re going to say, “If you are benefiting any of these people, then you’re taking advantage of your IRA.” And it wasn’t built for that.
Now, brothers and sisters are different, and third parties are different.
I guess, for example, I’d say if your IRA wants to buy a property and then hire me to be the realtor or the property manager, fine.
But you can’t hire your spouse to do it because you might pay them too much. You might also have them do it for free, which then benefits your IRA unjustly.
Now, there is a set of rules called prohibited transactions, but they are easy to understand and easy to comply with.
Don’t let some broker-dealer or investment advisor scare you or freak you out that you’re going to cause some massive problem with your retirement account. You’re not.
Now, let’s review where we’re at.
You’ve got a retirement account that’s been funded. Then you created an LLC, funded the LLC, and bought real estate.
Well, we need to maintain that LLC.
It may have to file a tax return because it could have other partners than just your retirement account.
You’ve got to maintain your IRA and do your annual reports to your trust company or custodian.
Keep them informed as to what you’re doing, but your LLC could move forward and own that property for many years to come.
Sell the property, and the money goes back to the IRA.
If it creates a lot of cash flow, you could deploy that money back to the IRA, or you could keep it in the LLC and buy another property.
But you have to maintain this business as an investment of your IRA, again, of which you get to be the manager.
But I want you to feel confident that, as you move forward with this investment strategy, you’re going to know all the procedures to maintain the LLC and, when it comes time to take out cash or sell the property, how that money goes back to your IRA and the procedures to do it.
But the real benefit is that you’ve diversified your investments.
Your retirement account is not just focused on Wall Street investments. It’s now more balanced.
It’s got real estate in it, as well as maybe cryptocurrency, stocks, bonds, and mutual funds.
You can invest in anything you want. That’s the beauty of self-directing.
And real wealth comes from balance, not just one strategy.
Anyone telling you there’s only one right way to invest is selling you something.
Buying real estate inside your retirement account is not only legal, but it’s also extremely powerful and incredibly profitable, especially when done correctly.
But the key is getting educated.
Once you understand all these steps in the process, it’s a whole new world that opens up to you.
