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What is a Self-Directed IRA and How Can I Use it to Buy Real Estate?

Posted at 02/14/2020 12:00 PM by Pat O'Connor

self directed IRA | real estate

Since 1974, a traditional IRA (individual retirement account) has been a mainstay of most everyone’s investment portfolio. The rules are pretty straightforward:

  • There are maximum contributions for each year. If you are under 50, that amount is $6,000; 50 and over individuals may contribute $7,000. You must have earned income that is at least that amount or have a spouse who has earned that amount and you file joint tax returns. If the spouse also contributes to an IRA, the earned income must cover both IRA contributions.
  • You aren’t required to contribute each year but yearly contributions are recommended. Kiplinger’s gives this example: If a 25-year-old opens an IRA and puts in $5,500 a year with an annual return of 6%, he will have a nest egg of $902,262 at age 65. If instead his savings were taxed at an annual rate of 25% over those 40 years, he’d end up with $615,157 at age 65.
  • The contribution is tax-free and will not be taxed until you start to withdraw from the account. The earliest age you can make withdrawals without penalty is 59½. The withdrawals will then be taxed at your ordinary income (in most cases).

In addition to traditional IRAs, there are a number of other types of retirement accounts ranging from Roths to SEPs to 401(k)s. 

One of the least understood types of IRAs is one that you “self-direct.” While the “self-directed” definition is more a marketing term rather than a “type”of IRA, it helps define the account. The account holder of a self-directed IRA is able to put money into a number of areas -- from startup companies to commercial real estate to investing in a rental property. One of the appealing aspects of this type of IRA is the amount of potential earnings is limitless, as long as you have a designated custodian of the account. You are able to actively manage the account but all transactions must occur through the account’s overseer.

Allison Hughes of New Direction Trust Company recently provided insight into a self-directed IRA and how it might help diversify your investment portfolio, minimize your tax burden and provide optimal return. Through a self-directed IRA, you can get started in investing in real estate and potential build wealth without tax recriminations -- as long as all transactions go through the custodian account, 

What exactly is a self-directed IRA?

"Self-directed is a marketing term, not a type of IRA. Clients can 'self-direct' any of their IRAs, including traditional IRAs, Roths, SEPs, SIMPLEs, solo 401(k)s, etc. The term 'self-directed' means that you (the client) are telling us (the custodian) what you want to invest in, and we are sending the money out to fund that investment." 

Who should consider establishing a self-directed IRA?

"Anyone who is interested in diversifying may opt to open a self-directed IRA. The important thing to remember is that not all custodians will allow clients to self-direct. Big brokerage houses, for example, will not allow their clients to invest in real estate. They may have public REITs available to invest in, but not a single property. These same companies often do not allow private equity/start-up investments either. "

Why should someone elect to set up a self-directed IRA?

"Self-Direction usually happens because custodians will not allow their clients to invest in alternative assets, so they have to find a company like ours to help facilitate that investment." 

How much money do you need to set up a self-directed IRA?

"New Direction Trust Company does not have a minimum amount to establish an account. However, the investment type will often determine the ballpark amount you will need. For example,  those purchasing precious metals will not need as much as someone purchasing real estate. Similarly, many private equity investments are as low as $5,000 and as high as $100,000. It all depends on what you plan on investing in." 

Like conventional IRAs, are there limits on how much you can contribute to a self-directed IRA?

"Yes. Your contribution limits will be the same as conventional IRAs. If you have a Traditional self-directed account, you can contribute $6,000 for 2020 if you are under age 50 and $7,000 if you are over age 50. "

What are some of the advantages of a self-directed IRA?

"Self-directed account holders are able to truly diversify their retirement accounts, investing in anything other than life insurance and collectibles." 

What are the tax ramifications of a self-directed IRA?

"They are the same as conventional IRAs." 

What are some of the limitations of a self-directed IRA?

"Clients cannot invest in life insurance or collectibles, and must follow the IRS rules for disqualified persons and prohibited transactions. Please go here for information on these disqualified persons." 

Explain what a “account custodian” is and what a custodian does.

"Custodians are the bookkeepers of the account, and file with the IRS on behalf of the IRA each year."

Explain or give an example of how a transaction occurs in a self-directed IRA. 

"For private equity transactions, these are the basic steps:

1) Open an account

2) Fill out transfer/rollover form to get money into the account.

3) Fill out our private equity buy direction letter and our indemnity agreement and get us the subscription documents from the company the client is investing in.

4) We then fund the investment." 

How would someone set up a loan through a self-directed IRA? For example, say you have $40,000 for a down payment for a rental home but need to secure a loan. How would that work? 

"Loans to IRAs are referred to as “non-recourse” loans. This means that if you default, the only recourse is to come after the IRA-owned property, not your personal funds. As such, not all lenders will lend to IRAs, and they typically require 30-40% down. New Directions Trust does have a directory of lenders who will make loans to an IRA account -- we are happy to help in directing you to an appropriate resource."


It’s imperative you understand that you personally can’t sign contracts; the IRA custodian must provide signatures for all transactions on the IRA account. Typically, all purchase agreements can take up to 14 days to complete. Also, you should be aware of the up front fees in setting up the account and yearly reporting requirements on real estate or LLCs held in the IRA. 

For more information on self-directed IRAs, contact New Direction Trust Company at 1-877-742-1270.

Posted by Pat O'Connor

Pat O’Connor has dual citizenship in both Wisconsin and Colorado, having been born and raised in Wisconsin Dells, but later adopted by the Centennial State. A graduate of the University of Colorado (B.S. Journalism, 1980), O’Connor began her career as a sportswriter at the Boulder Daily Camera under the tutelage of the venerable Dan Creedon. Her experience also includes stints in public relations at Aspen Highlands Ski Area, the Colorado Trial Lawyers and the Colorado Division of Wildlife. When she isn’t piecing together sentences, the self-proclaimed “Cheesehead” enjoys traveling, running, playing golf, hiking 14ers, horseback riding and skiing. During football season, she can be found cheering for the Buffs and "whooping it up" when the Packers win. She loves talking sports and giving recommendations on cheese curds.



Topics: Home Buying