Listener Q&A: How to Buy Real Estate In Your IRA and Why You SHOULD NOT DO IT | Episode 192

A listener asks: Exactly how can you buy real estate in an IRA? Today, I answer that basic question… and the more important question behind it: SHOULD YOU buy real estate in your IRA? I’m Bryan Ellis. This is Episode #192.

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Hello, SDI Nation! Welcome to the podcast of record for savvy self-directed investors like you!

Today, it’s back to basics day. But the “basic” idea we’re covering is one that many of you have done very, very wrong… and you don’t even know it.

Before I get into the meat of today’s show, may I ask a personal favor of you? Please say a prayer for my daughter Kayla. She’s 18, and tomorrow she’ll be having surgery that we’re hoping and praying will correct some rather severe skeletal and maybe neurological issues she’s having which are causing her really, really great pain. She’s connected to this show by more than just being my daughter… she is the person who edits and publishes this show so that you get to hear it. So please, please say a prayer for her. Kayla, I love you so much and I’m praying for you. And, of course, I’ll be there with you at the hospital constantly. God is with you, kiddo, so take heart and be full of courage!

I received a great question from a listener named Molly who had this excellent question for me: “Bryan, I really love your show, but I’m confused. I want to buy a house in my IRA. When I asked my IRA account people at Charles Schwab how to do this, they told me I couldn’t do it. What am I missing?”

Thanks for the question, Molly. And by the way – I welcome your questions at [email protected]. Molly, here’s the answer:

By law, there are very few restrictions on what kinds of assets can be purchased with an IRA, and there’s certainly no problem LEGALLY with buying real estate in your retirement account.

But different IRA Custodians – those are the companies that set up IRA’s, such as Charles Schwab in your case – different IRA Custodians allow different levels of flexibility in terms of the assets for which they will facilitate purchases.

In the case of Charles Schwab, they’re brokerage for stocks, bonds & mutual funds. In other words – the conventional Wall Street type of assets. And you know, I used to have an account with them. I always liked the service they provided and thought they were a good company.

But I had to move on from them once I realized it was possible to do MORE with my retirement account, and that’s what you’re going to need to do too, Molly.

Your next step is to transfer your retirement account from Charles Schwab to what’s called a Self-Directed IRA custodian. Now I realize that at Charles Schwab particularly, they do use the term “self-directed” to describe their IRA accounts. And to an extent, that’s true. But the truth is, accounts there are only self-directed to the extent that you choose to invest in an asset that they’re willing to sell to you, which unfortunately is limited to stocks, bonds, mutual funds and conventional Wall Street type investments. If you’d like to go outside of Wall Street investments, then you need a TRULY self-directed retirement account.

And never fear! I have a handy list of self-directed IRA custodians available to you at sdi360.com/custodians. There are a few dozen of them listed there from which you can choose.

So Molly, you’ll select a self-directed IRA custodian, transfer your account to that custodian, and then you’re ready to buy real estate in your IRA.

So what’s the process from there?

Well, the most important thing to remember is that it’s your IRA that’s buying the real estate, not you. Technically, it’s your IRA Custodian who is buying it for the benefit of your account.

So here’s how it works. What you do is negotiate the purchase contract just like normal… except that the BUYER will be your IRA custodian for the benefit of your account number. Confirm with your Custodian, but usually the buyer is listed as something like “XYZ Custodian for benefit of Joe Blow IRA, Account #123456”… or some variation of that. Just confirm with your custodian how they should be listed on the purchase & sale agreement.

Next, you’ll send in the contract to your custodian for signing, along with something that’s usually called a “direction letter”. Yep, you guessed it: It’s a letter than tells the custodian exactly what you want them to do, such as payment of earnest money and funding of the ultimate purchase. The custodian will then follow your instructions, return a copy of the signed contract to you, and you can proceed to due diligence and closing.

Note that every single expense involved in the process – including any costs of due diligence such as appraisals or inspections – must be paid by the IRA. To pay for such things out of your own pocket could be construed as a “prohibited transaction”… and that’s a bad, bad thing as you’ll see in a moment.

The benefit of doing it the right way, of course, is that when you sell that real estate, the proceeds of sale lade inside your IRA and you get to enjoy all of the tax benefits that make IRA’s so attractive to begin with!

So that’s how to buy real estate inside of your IRA. But Molly, I respectfully propose that you consider another question: SHOULD you buy real estate inside of your IRA?

Here’s my answer to that: If you can do it in some other way, you should avoid buying real estate in your IRA. Here’s why:

IRA’s are subject to something called “Prohibited Transaction” rules. Those are the rules that you absolutely can’t break with your IRA, and if you do, you’ve got a very, very serious and financially painful conflict with the IRS headed your way. This isn’t something to take lightly. And, unfortunately, the inherently complex nature of real estate transactions makes it not just plausible, but actually very easy, to commit a prohibited transaction.

What should you do instead to benefit from real estate in your retirement account? The absolute best way to do this is to use a self-directed 401k instead of a self-directed IRA. That’s because even though the same prohibited transaction rules apply to 401k’s as to IRA’s, the fact is that it’s far, far simpler and less costly to “repair” a prohibited transaction in a 401k than in an IRA. With an IRA, prohibited transactions are like Armageddon. With 401k’s, they’re more like a simple nuisance.

Another alternative is to structure the real estate transaction differently. Because of the unique tax advantages of real estate ownership, it’s frequently the case that you can do as well, and maybe even better, by buying the property outside of your IRA, while still using your IRA funds to do so. That’s a complex topic, and my advice is to spend a few bucks to hire a really bright attorney who understands both real estate and self-directed retirement accounts. There are only a few lawyers in the whole country with that skill set, and the very best of them is sdi360.com’s very own Tim Berry, who you can reach at sdi360.com/tim.

So there you have it, folks… how YOU can buy real estate in your IRA… and my thoughts on some better ways to do it.

My friends, invest wisely today, and live well forever!

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