May 23, 2024

11 Prevalent Questions from Self-Directed Real Estate IRA Owners, Answered

Written By: Daniel Gleich

Key Points 

  • Real Estate typically continues to be a popular investment commodity since it’s a tangible asset that will likely never reach a zero-dollar value.
  • The Self-Directed Real Estate IRA incentivizes investors by providing undeniable benefits such as tax advantages, retirement portfolio diversification, autonomy over investments, and the potential of alleviating risk.
  • New Self-Directed Real Estate IRA owners understandably have questions on best practices and how to adhere to compliancy. Madison Trust is enthusiastic about providing you with answers.
A couple admires a residential property they just purchased as an investment under their Self-Directed Real Estate IRA.

You may have your heart set on learning the realty ropes and are ready to take the plunge into real estate investing. If you’re interested in truly steering your own investments and are longing to begin saving for your retirement, Self-Directed Real Estate IRAs may make the perfect complement for your investing endeavors. Most newfound investors expectedly want all the information they can get regarding this innovative tool in the hopes of maximizing its full potential. Let’s get your questions answered: 

1. What Types of Real Estate Can I Invest in?

A country-side blue house sits surrounded by pink flowers, demonstrating just one of the examples of the various kinds of properties you can invest in with your Self-Directed Real Estate IRA.

When it comes to Self-Directed IRAs, you generally are permitted to invest in almost any type of alternative asset. The only types of investments that are not allowed are collectibles, life insurance, and S-Corporation stock. This translates over to Self-Directed Real Estate IRAs. Feel free to venture into any of these property types: 

2. How Do I Go About Investing in Real Estate with a Real Estate IRA Custodian?

To begin, you’ll need to create your Self-Directed Real Estate IRA. Madison Trust offers a simple, three-step process for setting up your SDIRA:  

  • Open a Self-Directed Real Estate IRA with Madison Trust by completing our easy online application.  
  • Fund your account by transferring or rolling over all – or a portion – of your funds from an existing retirement account, such as an IRA or 401(k), or by making an initial contribution.  
  • Instruct Madison Trust to send your Self-Directed Real Estate IRA funds directly to your investment.  
A Self-Directed Real Estate IRA custodian sits across a prospective investor providing them with educational resources on handling their investment property.

Before approaching the final step of directing your Self-Directed Real Estate IRA custodian where to send the funds, you’ll need to provide them with further information to ensure everything is in good order. The Buyer Name/Address on all required documentation must be listed as follows: 

Madison Trust Company, Custodian FBO First Name, Last Name, MTC Account #, and our address of 401 E 8th Street, Suite 200, Sioux Falls, SD 57103. 

Typically, your custodian will request a revised Purchase Contract if the buyer’s name is listed as anything other than your Self-Directed Real Estate IRA. Account holders must sign all documentation – their custodian will review the documents, and then sign off as the legal and binding signatory for the transaction once all documents have been approved.  

Madison Trust’s standard processing time is four business days from when the final version of all investment documents is received. If you opt for expedited processing, it will be completed in as little as two business days. 

3. How Do I Go About Paying the Earnest Money Deposit?

A notebook is open to a page reading, ‘Earnest Money’ indicating that this new investor is in the stage of submitting their Investment Authorization Form to their custodian.

An earnest money deposit (EMD) is a deposit made to express the dedication a buyer has in purchasing their respective, desired property. This helps relieve some of the uncertainty from the seller, as putting down a large sum of money proves your seriousness in pursuing their offering. One of the most common mistakes made by new Self-Directed Real Estate IRA owners is attempting to pay the earnest money deposit through personal funds. This would result in a prohibited transaction as IRAs mandate that all profits and expenses flow through the account. Failure to do this can result in compromising the integrity of your Self-Directed Real Estate IRA. 

Whether you owe an earnest money deposit or not, observing this flowchart can aid in explaining the best methods to continue trekking forward: 

Paying Earnest Money Deposit When Investing with a Self-Directed Real Estate IRA infographic, explaining what steps you should take dependent on whether you owe an earnest money deposit or not.

4. Who Manages the Property Once My Real Estate IRA Purchases It?

A couple paints and repairs their investment rental property, which is a prohibited transaction according to the IRS code.

As this is your investment property that you control, you’re capable of choosing your tenants, contractors, maintenance team, etc. If you consider yourself to be the ultimate handyman, you will have to forego putting in elbow grease. The IRS code prohibits you – as the account holder – from incorporating any of your own sweat equity into the property. Any self-performed services are deemed as untaxable contributions to your account. 

The same stands for any contractor bearing the label of a disqualified person. Disqualified persons are individuals or entities that are closely connected to you. Some examples are your spouse, your stepparents, your descendants, and the parents and descendants of your spouse. This also pertains to the fiduciary of your Self-Directed Real Estate IRA as well as any entity, corporation, partnership, or LLC that is owned 50% or more by you, or a disqualified person. To ensure you’re remaining compliant, it’s best to go over the complete list of disqualified persons in Section 4975 of the Internal Revenue Code. 

5. How Do I Go About Paying for Utilities, Repairs, and Mortgage Payments?

Ensure that all payments you place towards your hired maintenance team and mortgage flow through your Self-Directed Real Estate IRA. Paying any expenses out of your own pocket can subsequently produce a prohibited transaction. Likewise, if a tenant writes their rent check and makes it out to you personally, this can also compromise your account’s validity. Even though you are the IRA owner, you as an individual are not legally declared as the investor – your Self-Directed Real Estate IRA is. Keep this in mind when making a payment or accepting one. 

A couple shakes hands with the leader of the contracting team they hired to manage the overall maintenance of their investment property.

6. Can I Take Out a Mortgage to Purchase a Property with My Real Estate IRA? 

A sign over graphs stating, “Non-recourse Loan” which is the best type of loan regarding all kinds of IRA accounts, including the Self-Directed Real Estate IRA.

There’s no need to have a bulk of cash ready or to empty your personal savings to purchase your desired real estate property. You’re entirely eligible to take out a loan through your Self-Directed Real Estate IRA.  A non-recourse loan is generally the route to take, as it’s an investment property-specific mortgage. 

A non-recourse loan is crucial for this undertaking as it means it will be guaranteed by the Self-Directed Real Estate IRA as opposed to you as the account holder. This will leave the respective investment property in question as collateral instead of any other assets being held within the IRA, or any money or treasured items owned by you personally. To achieve results that best coincide with your financial goals and circumstances, consider consulting with a tax advisor who’s familiar with tax implications on leveraging retirement accounts. 

7. Am I Allowed to Temporarily Live in My Real Estate IRA’s Property or Let My Family Stay There?

Any investment you make within your Self-Directed Real Estate IRA is intended to serve you during your retirement, and not in the present day. Because of this, staying at your own investment property – even temporarily – is marked as a prohibited transaction. This includes renting out your beloved vacation property to yourself, or letting you stay the weekend in one of your vacant condos while your house is being remodeled.

A third-party family moves into their new rented home, excited to begin their next chapter.

If your family member falls under the disqualified persons collection, unfortunately, you are unable to offer up your property to them either. Even if they agreed to pay to rent out your condo, these transactions would be viewed as inadmissible.  

8. How Do Taxes Work When Investing in Real Estate with a Real Estate IRA?

Self-Directed Traditional IRA vs. Self-Directed Roth IRA infographic, which compares the two accounts showing their respective benefits and protocols.

One of the major benefits of acquiring a Self-Directed Real Estate IRA is your gains continue to develop in a tax-advantaged environment. If you open a Self-Directed Traditional Real Estate IRA, your earnings (including any investment returns and rental income) will grow tax-deferred. If you decide you’d prefer to pay all your taxes upfront upon creation, a Self-Directed Roth Real Estate IRA will let your funds accumulate tax-free.

Any contributions you make to your Self-Directed Real Estate IRA are generally tax-deductible (in accordance with qualifying factors such as income limitation). When you reach the age of 59 ½ and are eligible for distributions, or you reach the age of 73 and must participate in required minimum distributions (as of 2024), Self-Directed Traditional IRA distributions are taxed as income when withdrawn. In a Self-Directed Roth IRA, qualified distributions are tax-free. If you determine you need to withdraw distributions before turning 59 ½, you could very well be subject to early withdrawal penalties in addition to taxes, sans an accepted exemption.  

When it comes to securing the seemingly best conditions for your investing pursuits, tax advisors and Self-Directed Real Estate IRA Specialists are available to help provide you with as many educational resources as possible. 

9. What if I Intend on Investing in Multiple Properties with my Self-Directed Real Estate IRA?

If you’ve determined that your real estate investments will equate to heavily performed transactions, you may want to upgrade your account with the supercharged power of checkbook control. Checkbook control allows you to invest in real time and seize any sudden opportunities. You will no longer need to involve your Self-Directed Real Estate IRA custodian in your everyday investing transactions. This indicates you will avoid the many transaction fees typically affiliated with Self-Directed Real Estate IRAs. 

A blue checkbook with pen, expressing that through the power of checkbook control and a Self-Directed Real Estate IRA LLC, you can potentially accumulate greater gains.

By securing checkbook control, your account will be further strengthened by transforming into a Self-Directed Real Estate IRA LLC or Self-Directed Real Estate IRA Trust. Being able to invest according to your own schedule and timeframe can potentially amount up to more for your retirement savings. Moreover, IRA LLCs provide superior liability protection to your account. IRA Trusts are generally more cost-effective and have a significantly shorter set-up time. 

10. Is it Possible to Avoid Unrelated Business Income Tax? (UBIT)

Keeping the Distance Between House Flipping & Unrelated Business Income Tax infographic, showing the factors that the IRS considers prior to claiming your account has generated UBIT.

Perhaps you’re inclined to participate in real estate investing involving repetitive transactions - such as house flipping. This could potentially trigger Unrelated Business Income Tax within your Self-Directed Real Estate IRA. UBIT is tax imposed on active income that’s generated within any kind of IRA.  

The factors IRS typically review to determine this are the frequency of your transactions, the behavioral pattern you demonstrate as the account holder, and the entire compass of transactions within your Self-Directed Real Estate IRA. There’s no specific number that will signal warning flares to the IRS.  

A method that may prove to be strategic in possibly evading UBIT is to invest your Self-Directed Real Estate IRA into a UBIT blocker C-corporation. This tries to lessen the owed taxes you’ll have at the end of the year by quintessentially, “blocking” the UBIT and tackling a generally lesser, corporate tax. This blocker serves as an intermediary between your Self-Directed Real Estate IRA and the investment spawning the unrelated business income tax. Prior to implementing this tool, it’s strongly encouraged that you consult a financial advisor to determine if this method is right for you. 

11. Is There Any Way to Personally Own my Self-Directed Real Estate IRA’s Property Once I Choose to Retire?

Upon reaching retirement, you may realize you no longer want to handle your investment property. There may be a strong chance you wish you could stay in this property for daily residency, or to keep available for your vacations and moments of leisure. Distributing your property to yourself over a set number of years can make this possible. This is what’s referred to as in-kind distributions, or distribution-in-specie, and is a form of payment through assets. 

In-kind distributions permit assets to be removed from an account without liquidating them. Utilizing in-kind distributions will swap the ownership title from your Self-Directed Real Estate IRA to your actual birthname, knighting you as the official owner of your investment property.  

Building Block Points: Obtaining Real Estate from In-Kind Distributions infographic, which relays important considerations when deciding to distribute your investment property in-kind.

Note: If you upgraded your account to an IRA LLC, you’ll need to first convert your account back to a classic SDIRA. Taking distributions from an LLC is considered a prohibited transaction. 

Plots, Parcels, and Potentially Prosperous Property Investments

The financial mascot, a piggy bank, in blue, coordinating with the colors of Madison Trust Company, nestled beside a property model.

Self-Directed Real Estate IRAs are extraordinary vessels for property investing. Besides gracing you with tax advantages and the possibility of immense and increasing appreciation, it also lets investors home in on alternative assets that are typically uncorrelated to Wall Street products and the general ebbs and flows of the stock market. This leads to retirement portfolio diversification, potential mitigation of risk, and likely safeguards the savings you’ve gathered for the future.

Planning and preparation are key to establishing the best overall situation for your real estate investing experience. Knowledge is power, and our Self-Directed Real Estate IRA Specialists are here to assist. Schedule a free discovery call today to collect all the information you’re seeking. 


Disclaimer: All of the information contained on our website is a general discussion for informational purposes only. Madison Trust Company does not provide legal, tax or investment advice. Nothing of the foregoing, or of any other written, electronic, or oral statement or communication by Madison Trust Company or its representatives, is intended to be, or may be relayed as, legal, tax, investment advice, statements, opinions, or predictions. Prior to making any investment decisions, please consult with the appropriate legal, tax, and investment professionals for advice.

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