How You Can Start Buying Real Estate Using Your 401(k) or IRA

Written on June 05, 2023 by Daniel Gleich

This article is presented by Madison Trust. Read our editorial guidelines for more information.

Did you know you can buy real estate using your IRA or 401(k)? Most real estate entrepreneurs are unaware of how easy it is to buy real estate with their retirement money. 

Welcome to the world of Real Estate IRAs.

1. What is a Real Estate IRA?

A real estate IRA is a supercharged IRA that enables you to invest your retirement money directly into real estate such as multi-family, commercial, land, fix-and-flips, tax liens, and more. It has the same tax benefits as a regular IRA and can be set up as a Traditional, Roth, or SEP Real Estate IRA. 

A Real Estate IRA is also known as a Self-Directed IRA.

2. How Does it Work?

Opening a Real Estate IRA can be done in three simple steps: open, fund, and invest! 

Step 1: Open: You select a Self-Directed IRA Custodian and open your account by completing their online application. 

Step 2: Fund: To fund your account, you transfer or rollover all, or a portion of, an existing IRA, 401(k), or other retirement accounts or by making an initial contribution. 

Step 3: Invest: You instruct your Self-Directed IRA Custodian to send your retirement funds to your real estate investment. 

The process, from start to finish, is typically 1-3 weeks.

You may want to consider upgrading to a Checkbook IRA—which will enable you to manage your IRA without the need to contact your Self-Directed IRA Custodian for everyday transactions—thus saving you time and money.

3. Real Estate IRA Do’s and Don’ts   

So, what can and can’t you do with real estate in your IRA?

Since your IRA is intended to provide benefit for you in retirement, not today, there are a few rules in place that ensure all benefit is preserved for the future—when you retire.

Rule #1: You and your immediate family members, such as your spouse, your parents and grandparents, children and grandchildren, and their spouses, as well as the entities they own—collectively known as “Disqualified People”, cannot benefit from your IRA today.

The most popular question we get is, “Can I live or vacation in a property owned by my IRA?” Unfortunately, you cannot until you retire and withdraw the property from your IRA. Many people, therefore, buy a property now, rent it out, then at retirement withdraw the property and live in it.

Rule #2: The same group of “Disqualified People” cannot transact with your IRA.

The second most popular question we get is, “Can my IRA purchase a property that I currently own?” Unfortunately, not. This is because if a Disqualified Person transacts with your IRA, it is considered “Self-Dealing” and is not allowed. All transactions with your IRA must be at arm’s length with a non-related third party.

Another popular question we get is, “Who can and who can’t perform work on the property?”

The answer is that all work done on the property must be done by unrelated third parties. 

The last question for now “How about if I do the work but don’t get paid for it?” 

That would be considered “sweat equity,” which would be a non-cash contribution to your IRA—and, unfortunately, is not allowed. You can, however, perform “desk work” such as hiring contractors and subs, paying the bills, collecting the rent, overseeing the property, etc. 

Rule #3: All income and expenses must flow directly into and out of your IRA. Always remember that you and your IRA are separate entities.

4. Non-Recourse Financing for Your IRA    

There’s always more real estate to buy than there is cash on hand. That’s why most savvy real estate investors use leverage to grow their portfolios.

When using leverage in an IRA, there are a few things you need to know.

Firstly, you cannot borrow money from “Disqualified People” (the immediate family members listed above)—you can only borrow from unrelated third parties.

Secondly, you cannot personally guarantee the loan. It must be a non-recourse loan.

Thirdly, when an IRA borrows money, the net income attributable to the loan is known as UDFI, Unrelated Debt Financed Income, and is subject to a tax. Although nobody likes to pay taxes—especially in an IRA—when you do the math, it’s almost always worthwhile because, at the end of the day, you are left with more money than if you did not take out the loan. Your Self-Directed IRA Custodian can walk you through the math if you’d like.  

5. Upgrading to a Checkbook IRA   

You may want to consider upgrading your Self-Directed IRA to a Self-Directed IRA with Checkbook Control. This will enable you to manage your IRA without the need to contact your Self-Directed IRA Custodian for everyday transactions—thus saving you time and money. 

Checkbook Control is very appropriate for investments like real estate that have a lot of transactions—or if you are holding many investments in your IRA. 

Upgrading to Checkbook Control only adds one extra step to the process!

How does it work? It’s typically a simple four-step process—open, fund, create, and invest!  

Step 1: Open: You open your account as described above. 

Step 2: Fund: You fund your account as described above. 

Step 3: Create: Your Self-Directed IRA Custodian establishes a new LLC or Trust for your IRA—which will serve as your IRA’s self-directed investing platform. You are appointed as its manager or trustee, authorized to make all investment decisions. At your direction, your Self-Directed IRA Custodian will fund your IRA LLC or Trust at the bank of your choosing. 

Step 4: Invest: You can begin placing investments by simply writing a check or sending a wire.  

The process, from start to finish, is typically 2-3 weeks.

6. Airbnb and Vrbo in Your IRA

“Can my IRA invest in an Airbnb or Vrbo?”

Yes, it can, but here is why it’s even a question. As a relatively new asset class, it is not referenced in the Internal Revenue Code. It falls somewhere between a typical rental property and a hotel.  

A typical rental property is considered a “passive” investment and is non-taxable. A hotel, on the other hand, is considered an “active” investment—and if held in an IRA, would trigger a tax known as UBIT, Unrelated Business Income Tax.

So, the question is: What is Airbnb or Vrbo considered? And is it subject to UBIT?

The IRS has not issued clear guidance on this. So, what do you do?

Here’s the general guidance we’ve received—so long as you don’t provide daily maid service, breakfast, or other personal services that a hotel offers, it is likely not considered “active,” and UBIT would not be applicable. If Airbnb or Vrbo is part of your strategy, you should consult your tax advisor.

7. Fix-and-Flips in Your IRA

When buying a property in an IRA to fix-and-flip, there are two main considerations you need to be aware of: 

1. UBIT, Unrelated Business Income Tax, and 
2. Who can and who can’t perform the actual renovations

When you purchase a property in an IRA and rent it out—it is considered a “passive” investment, and the income is non-taxable. When you fix-and-flip properties in an IRA—it may be considered an “active” investment—and may be subject to UBIT, Unrelated Business Income Tax. The IRS has not issued clear guidance on this. So, what do you do? The general guidance we’ve received is that if you flip multiple properties, two or more, within a short period of time, less than 12 months, you’re likely subject to UBIT. Less than that, or over a longer time frame, you’re likely not. If fixing-and-flipping is part of your strategy, you should consult your tax advisor.

The second consideration is “Who can and who can’t perform work on the property?”

The answer is that all work done on the property must be done by unrelated third parties. 

“How about if I do the work but don’t get paid for it?” 

Once again, that would be considered “sweat equity,” which would be a non-cash contribution to your IRA—and, unfortunately, is not allowed.

8. Land in Your IRA

Land is a very popular Self-Directed IRA investment choice. IRA Investors typically buy and hold land because, historically, it appreciates over time, which is ideal for an IRA’s long-term investment horizon. The main thing you need to know about buying land in your IRA is that all expenses—such as the real estate taxes—must be paid by your IRA and not by you personally.

Additionally, you cannot pay the expenses personally and then get reimbursed from your IRA. Your IRA must pay them directly—or through a third party, such as a management company.

9. Tax Liens in Your IRA

Bidding on tax liens is a time-sensitive investment that requires you to have funds immediately available when bidding. This is where the power of a Self-Directed IRA with Checkbook Control comes into play. Whether in person or online, you always have instant access to your IRA funds enabling you to purchase the tax liens without having to go through your IRA Custodian.     

10. How do I Choose the Right Self-Directed IRA Custodian?

There are three factors to consider when selecting a Self-Directed IRA Custodian—customer service, reviews, and fees.

You want to choose a trusted company that has a knowledgeable and friendly staff based in the U.S. who answers the phone without making you wait. They should have thousands of 5-star reviews across multiple online platforms such as Google, Yelp, BBB, and Facebook. 

Self-Directed IRA Custodians structure their fees as either flat-rate or asset-based. Flat-rate is when the fee is fixed regardless of the value of your account. Asset-based is when the fees are based on the value of your account. The larger your account, the larger the fees. You want to choose a trust company that offers a flat-fee structure, so you pay less in fees.