How I Bought Real Estate With My IRA

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I’ve written before on Investor Junkie about how I worked in publishing for 25 years, retired and then started a second career as a full-time real estate investor. But how did I do it?

In the fall of 2015 I moved my retirement funds from a professionally managed IRA to a self-directed IRA (SDIRA). I liquidated a chunk of my stocks, bonds and mutual funds and instead invested in real estate. Specifically, I bought three rental properties — while retaining all the benefits of doing so with my qualified tax-deferred retirement savings.

It took a lot of strategic planning and research, but it was well worth it. I had no experience in real estate investing when I started. Now, 15 months later, I have purchased, rehabbed and rented three properties, and all of them are predictably and steadily generating monthly rental income for my retirement account.

Step One: Study Real Estate, Understand SDIRA Rules, Select Custodian

  • I studied how real estate investors make money. I went to local Real Estate Investors Association (REIA) meetings and talked to investors with boots-on-the-ground experience. I got books out of the library by the armful and took notes. I browsed websites and discussion forums and found them extremely helpful — my favorites are BiggerPockets and InvestFourMore.
  • I had to read a lot about SDIRAs and what exactly the rules were. For IRAs to be legit, the IRS requires that a licensed “custodian” complete all transactions on behalf of the IRA owner. These custodians will say you can’t invest in real estate using the funds they manage. But that’s not true. You can invest your IRA funds in real estate; you just can’t do it with most IRA custodians (who limit investments to stocks, bonds and mutual funds). To invest in real estate, I learned, I needed a custodian that offers “alternative investments.”
  • The custodians that offered alternative investments differed greatly in fees, customer service, levels of expertise, etc. Not having experience, I didn’t know what options I would prefer! So I ventured forward and chose a company with a demonstrated knowledge base and a good reputation (online). I didn’t go cheap, but I didn’t pick the most expensive option with bells and whistles I wasn’t sure I needed.
  • After transferring funds from my IRA to the SDIRA, my next step was to acquire from them a proof of funds (POF) letter. I needed this letter to show the property sellers I had cash and was serious. Tip: I learned agents like letters dated within 30 days, so I have asked for multiple letters over the last 15 months.

I’m happy with the custodian I chose, but please understand the heavy lifting was on my shoulders. Custodians that allow for alternative investments like real estate investing do not educate you or offer best practices. They simply execute your instructions and issue funds from your retirement account. In other words, do your homework!

Step Two: Select Agent, Research Market, Buy Home

  • I discovered there are a lot of part-time “agents” — licensed individuals who dabble in real estate as a side hustle. There's nothing wrong with that, but I preferred a full-time, dedicated agent. I was a serious investor and wanted someone who was in the market daily, familiar with listings and ready to work hard so we may both succeed. The agent I chose was:

    • A licensed appraiser as well as an agent — a huge plus because he would spot structural problems and inspection issues right away.

    • Backed by a company that has a good reputation for sales and integrity.

    • Friendly, knowledgeable and honest.

    • Not embarrassed or resistant to making lowball offers on my behalf to get the best deal possible.

  • I’d lived in my target market (Maryland) for decades but had to research market home values, projected rents, estimated holding costs, vacancy rates, average associated expenses and so on. My agent set up an MLS search that sent me listings in the zip codes I selected. I also did my own research. My three go-to sites were RedFin, Trulia and Zillow.

  • The first property I made an offer on was a two-bed/two-bath condominium built in 1992. My agent prepared the offer — in the name of my custodian. When you purchase assets through an SDIRA, your IRA owns the property (not you personally). I was nervous, but I double-checked all my math and assumptions and felt confident the property was a good long-term rental property.

  • Offer accepted! The contract was finalized and the closing was scheduled. Closing is unique when purchasing property through an IRA — you don’t sit in a conference room and sign paper after paper for hours. Instead, my custodian signed everything on behalf of my IRA. Of course, I had reviewed and approved everything and authorized the settlement funds to be wired out of my account ahead of time.

Step Three: Get the Property Rent-Ready

Once everything was official and I was given the keys, I walked through the condo and created a “scope of work” detailing what needed to be done. This first property was what rehabbers call a “carpet and paint.” There were no holes in the wall, the appliances worked, the roof didn’t leak and the structure was sound. After a deep cleaning, fresh carpet, fresh paint and a few upgrades, the property would stand out in the rental marketplace.

One of the most important rules with SDIRA investing is the owner of the IRA cannot do any of the rehab work themselves. I posted the jobs that needed to be done on HomeAdvisor. Immediately, contractors in the area who wanted to bid on the work contacted me. This was my system:

  • I placed a lockbox on the property so contractors could stop by the property to examine the job themselves without my needing to be there (I changed the combination weekly). They then would email me price quotes.
  • For each job, I reviewed three bids and did my due diligence — making sure the contractors were licensed and had positive reviews on HomeAdvisor.com.

  • Next, I hired and scheduled the work. I never paid contractors upfront — which is the primary reason I don’t use Angie’s List, where you pay for work before it’s done. All contracts detailed the work to be done, the agreed-to price and the agreed-upon schedule/completion date and were signed by my custodian.

  • To pay the contractors I authorized my custodian to provide a deposit when signing the contract and the remaining balance when the job was completed.

When you invest in real estate using an SDIRA, you will never pay for anything personally. Everything is signed and paid for by the custodian with your approval. The process is very simple: Complete and sign a “direction of investment” form, and the custodian sends the check wherever indicated.

Step Four: Rent the Property

The condo took me four weeks to get move-in ready. I know now that this was fast. The next step is to find tenants.

  • The condo had never been rented before, so I learned I had to get a county inspection and rental license before I could legally place a tenant. They told me I needed to add a second fire alarm.
  • I hired a property management company that created a legal Maryland rental lease and placed the tenant I approved after conducting background and employment checks.

  • The security deposit and monthly rent were set up to be sent directly from the tenant to the property management company to my IRA custodian. Remember, as the IRA owner, I am not allowed to touch the money.

In Summary…

I have repeated this process, acquiring several more rentals in my IRA. Now I'm working with my personal funds to invest.

There are strict rules when investing through an SDIRA — and you need to understand them inside and out. The rules fall under two important things you must avoid: “prohibited transactions” and “disqualified persons.” The consequence of breaking the rules is disqualification of your entire retirement account as of Jan. 1 of the year the transaction occurred. When the retirement account is thus closed, the IRS will charge hefty penalties and of course taxes.

These severe consequences intimidated me at first, but knowledge is power and I gained confidence the more I learned. The ability to truly understand and direct my retirement funds is important to me, and in getting there I’ve landed a second career I enjoy immensely.

What do you think about this strategy? Is real estate investing something you'd like to try for yourself?

Ruth Lyons

Trading three decades of financial publishing experience in the corporate world for a life of personal and financial freedom as a freelancer in 2012, Ruth is passionate about helping others take control of their personal finances and to become aware and educated on their options as self-reliant individuals. Disenfranchised with the high cost and lackluster performance of her IRA, college savings and other retirement accounts handled by a full-service broker, Ruth moved her retirement money to a self-directed IRA in 2015. Ruth holds an MS in Finance from Johns Hopkins Carey School of Business (1991) and a Business Management degree from University of Maryland (1984). You can follow Ruth on: Twitter

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13 Comments

  1. I’m not in the real estate business, neither as a realtor or a broker. I have made many investments however, some which I’ve regretted, and others becoming very fruitful.

    My comment is based upon a generalization that you made, implying that those that only currently working part-time in the business, are “hustlers” that merely “dabble” in the business. While this may be true with some of those only working part-time, it is an ignorant generalization to assume that all only working part-time have those undesirable qualities.

    You, as an example, are ‘experimenting’ with the populating of your ira with real estate, and by the writing of this post implying that you are somewhat of a trail-blazing pioneer that should be viewed as an authority on the subject. Even going as far as offering to help others with generalized questions they may have.

    Is this your full-time dedicated vocation? Would you perhaps understand that the descriptors “dabblers” and “hustlers” (their part-time hustle) might be offensive to those who are working part-time while building their practice?

    I am proud to work with these part-timers, as they show a dedication and initiative that few people possess. They want something more. Something better. At the same time, they have responsibilities to their families, and are willing to push through. First, provide, then work on their dream. How easy would it be to plop into the couch after a long days work? These ‘part- timers’, tired as they are, clean themselves up, and the go to work on their second job. The job of their dreams. “It won’t be forever” they keep telling themselves, to keep going and build their business. And what labels do you have for them? It’s not your responsibility to ENcourage them, but why say such things that only serve to DIScourage someone?

    I’ve used several part-timers that have shown a level of professionalism and energy that you just don’t find very often in the more complacent ‘full-timers’.

    Just because someone has been doing something for a long time does not automatically mean they do it well. If that were true, then every driver in their 60’s would be ‘the best ‘ since they’ve been driving for so long. That is, of course, a generalization far from reality.

    I’m writing to suggest that as a part-timer yourself (in ira investing) that you write further articles with a little more consideration and awareness as to how you lump groups of people together, and then characterize that group with very unflattering assumptions.

    1. Thank you for your comments, Richard. While I didn’t mean my comment to be a discouragement, I can certainly see how it came across that way now that you’ve pointed it out. My generalization was unfair and I apologize to everyone offended by it. I appreciate the suggestion, too, and I will certainly pay more attention to the characterizations I make in future articles.

  2. When you finally have to take distributions from your IRA, how does that work? Is there capital gain inside an IRA if you sell the property?

    1. Hi Jen,
      Thanks for your question. Traditional IRAs are tax-deferred, meaning that the money you put into the account is pre-tax and it grows tax-free. When you withdraw the funds at retirement, you pay taxes on your withdrawals as ordinary income. There are no capital gains tax. Alternatively, Roth IRAs are funded with post-tax dollars. Here’s a link to an article that explains the difference.

      https://investorjunkie.com/38369/roth-ira-vs-traditional-ira/

      A self-directed IRA can be a Roth or Traditional.

  3. Thank you, Richard. While I didn’t mean for my comment to be a discouragement, I can see how it can be taken that way now that you’ve pointed it out. My generalization was unfair and I apologize to anyone who was offended by it. I will certainly consider your suggestions with regard to future articles. Thanks for taking the time to reach out and leave your thoughtful comments.

  4. Hi Jen,
    Thanks for your questions. Contributions to a traditional IRA are pre-tax. When you withdraw money from the account, you pay income tax on the distributions. There are not capital gains taxes, per se. Of course, Roth IRAs are post tax. An SDIRA can be either a Roth or a traditional IRA.

  5. I liked the article and the idea of real estate investing, but this seems like many ways to Sunday you could mess something up and get your account dis allowed, Plus having to keep messing with the custodian to get stuff done seems to be somewhat burdensome.

    I have another take on the idea I think would be less complicated and allow you to do most anything with your money without the custodian including paying yourself. I would like to hear your thoughts on this.

    1) Start a C-Corporation for purpose of real estate investing. Can be set up with secretary of states office for just a few hundred dollars.

    2) Use a financial institution to create a 401K plan for your new C-Corp. Typically the custodial setup fees are $5-7k. Have one of the offerings in your 401K as stock in your new C-Corp company.

    3) Now roll over funds from other retirement accounts and IRA’s to you new C-Corp’s. 401K. Use the funds to buy your C-Corp’s stock.

    You now have cash in your C corp for the shares you bought and your custodian of your 401K has shares of your company in your account.

    4) Now take your C-Corp cash and buy property, repair anyway you like but following local laws, heck even pay yourself a salary if you like. Your C-Corp runs like a business and your 401K as an employee of the C-Corp goes up/down in value by the retained earnings in your company and the appreciation or loss of real estate.

    5) The final benefit in this method is you if you are still doing this once required distributions start you simply pull funds from 401K and buy shares in your company if you would like. You will also protect your like kind replacement of investible asset if it still exists in a few years. In doing the other way the property is listed under the custodian, so if you ever wanted to pull out of your SDIRA, you would not be able to take funds and buy replacement property to keep from paying capital gains taxes. Having the C-Corp. the property is in the C-Corp even if you pull funds out the entity owning the propery won’t disappear do you can still sell and trade up deferring taxes on the property gains. This would be huge as value of property becomes high vs most of it being depreciated

  6. incredibly helpful! i’m considering my first real-estate-through-ira purchase. wanted that day to day breakdown of what can and cant be done. will reread and recommend this.

  7. Once you are 70 and need to start taking money out of the IRA how do you withdraw money that is invested in Real Estate??

    Love all the information

    1. Hi Susan,
      I’m not there yet, but my plan is to liquidate my holdings one by one when/if I need to. The rental income is substantial for these properties and when combined with my other retirement income, I will be able to hold them. It takes longer to sell real estate than stocks, so planning is key and I’ll watch for the right market opportunity to sell rather than “need” to sell.

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