11 Pros and Cons of a Self-Directed IRA for Real Estate

Share on facebook
Share on twitter
Share on linkedin
Share on email

Disclaimer: The following article is meant for educational purposes only and should not be taken as professional tax or legal advice.

Using a self-directed IRA for real estate investing, you can build your retirement savings in a tax-advantaged account while benefiting from the strong performance of real estate returns.

But this is your retirement nest egg we’re talking about, not a pet project investment. While a real estate IRA holds significant growth potential, you shouldn’t be blinded by the positives of these accounts and miss the potential drawbacks that could harm your savings.

In this article, we’ll highlight the pros and cons of using a self-directed IRA for real estate so you can make an informed investment decision.



Tax-advantaged growth

You can open a self-directed real estate IRA as a traditional or Roth account, giving you tax-advantaged growth.

With a traditional account, you will pay no taxes on your contributions but pay them when you take distributions, giving you tax-deferred growth.

If you set up a Roth account, you will pay taxes on your contributions but make tax-free withdrawals, giving you tax-free growth.


If you already own stocks, bonds, and CDs in other funds, setting up your retirement account with real estate will further diversify your assets.

Diversifying through real estate investment can be especially valuable for people who are closer to retirement age looking to avoid volatility.

Greater control:

“Self directed” says it all. While your custodian will help you with compliance, you will review all the disclosures, appraisals, offers, etc. and decide when to buy or sell.

Unlike investing in something like a REIT, where management makes the decisions, you pick the market, the building/house, etc. and whether it’s going to be a buy-and-hold or fix-and-flip strategy.

Tangible asset:

Real estate investing can be more straightforward compared to some other investments as it’s literally a “bricks and mortar” business. Factors like market comparables, rental rates, and interest rates determine its value.

When buying stock in a company, you’re putting your faith in their management and relying on the accuracy of their reporting to back up the stock price and influence its gains. And if it’s something like an experimental technology company, you may not be able to gauge what direction, if any, it’s headed.

Forcing appreciation:

Unlike directing an IRA into stocks and bonds, where your retirement funds are at the mercy of the markets, using an IRA for real estate gives you the option to take action and force appreciation.

Rather than wait for a natural rise in value over time, by making improvements to real estate owned by the IRA, you can raise rental rates and property values on your own.



Time commitment, higher risk and potential for fraud

While a self-directed IRA custodian will help with IRS compliance, they cannot assist you with due diligence. You alone must take the time to review all documents and evaluate every deal.

Even if you’re experienced in real estate matters, acting alone opens you up to a greater potential for oversights and being defrauded.

Prohibited transactions and no friends or family benefits:

The IRS lays out all its rules for self-directed IRAs, and your custodian will help ensure compliance. But while the basic concepts as they apply to real estate seem straightforward, the full set of rules are notoriously murky. Failure to comply will immediately make the IRA taxable.

Another downside is that the IRS prohibits “self-dealing” or allowing the property to benefit any relation. This means, when you purchase property through an IRA, you lose the utility of a second home. For example, a vacation rental can provide a friend or family member a free stay, or an investment house can be a backup home to move into or sell in case you fall on hard times. With your investment property locked in an IRA, these benefits are off-limits.

Custodian and other fees:

A typical stocks and bonds retirement account through a brokerage will clearly list their fees, and their impact on your savings can be anticipated over time. It’s one party to pay at one rate.

With a self-directed real estate IRA, you must pay a variety of parties. These fees can add up, and their costs are more difficult to anticipate. For example, you will pay fees to your custodian, for appraisals, to vendors for repairs, and more.

Lack of liquidity:

While you won’t expect to take distributions until retirement, plans change and financial emergencies happen, such as unexpected medical costs.

If you need to make an early withdrawal, in addition to paying a penalty, it could be tough to get money back that’s tied up in a real estate deal. And unless you’re operating with checkbook control, your custodian processes all transactions, and it may take them time to approve the release of funds.

No depreciation, ordinary income tax, unrelated business income tax

Although you gain a tax-advantaged retirement account, you lose the tax offset of real estate depreciation, one of the strongest benefits available to real estate investors.

And if you sell real estate within your IRA, any gain is subject to ordinary income tax. Real estate sold outside the IRA would be subject to capital gains taxes, which are generally lower.

Lastly, you may have to pay unrelated business income tax (UBIT) if you generate profit that the IRS classifies as non-investment income.

Large capital requirements:

2020 total IRA contribution limits are $6,000 or $7,000 if you are age 50 or older, but you will need enough capital in your IRA for a down payment. Though you can partner with others or other IRAs in a purchase, this could limit your buying power.

But it doesn’t end there. Any maintenance costs and other fees, which can be hard to predict, must come directly from the IRA. Should you run out of money in your account to pay expenses and need to add additional funds, you will face overcontribution penalties. 

Lastly, when you reach an age where you’re required by the IRS to take account distributions, you must make those withdrawals while still leaving behind enough money to cover your property’s maintenance or other expenses. This is no easy balancing act.


A powerful retirement vehicle, but does it fit your investor profile?

Combining excellent real estate returns with a tax-advantaged account, a self-directed IRA used for real estate can be a powerful vehicle for retirement savings, but only when the conditions are right. You’ll need significant capital, free time, and expertise on your side to make it work.

While the pros and cons should be measured, your status as either an active or passive investor is equally important.

“Self-directed” means taking your destiny into your own hands. At the least, make sure you are a committed, active investor who can handle risk before beginning this journey, and ideally one with a breadth of real estate experience.

Passive investors looking to build retirement savings with real estate could consider investing in a real estate syndication or REIT. After all, there’s no law saying money used to retire must come from a retirement account.

At Birchstone Investments, we help investors create passive income streams and grow long-term wealth through strategic multifamily real estate investments. If you’re interested in learning more about commercial real estate investment, join our investor community today.


Join the Birchstone Investor Community

Want to see current investment opportunities & receive our newsletter?

Jerry Hollifield

Jerry Hollifield

Jerry is the Managing Principal & Chief Investment Officer at Birchstone Investments, LLC. With a business career that spans more than 30 years, he has been involved in the acquisition, development, financing and management of over $400 million in real estate. In addition, he has been involved in more than 40 Merger and Acquisition transactions with total value exceeding $600 million.

Leave a Reply

Real estate investment fund

Birchstone Investments is a real estate investment and management firm that gives you the benefits of investment-grade multifamily real estate without the headaches of having to deal with day-to-day property operations.


Sign up  to receive news and updates from Birchstone Investments

By submitting this form, you attest that you have read our Privacy Policy and agree to our Terms and Conditions.