Investing in real estate with a Roth IRA is possible (and completely legal). However, you need a special kind of Roth IRA, the self-directed IRA (SDIRA).

While your investment options are limited to only traditional assets with a regular IRA, a self-directed Roth IRA opens the door to alternative assets like crypto, NFTs, private equity, precious metals, and real estate.

Real estate is one of the most common alternative assets to invest in with a self-directed Roth IRA. You can use your SDIRA to invest in single-family or multi-family homes, commercial properties, apartment buildings, and raw land and lots. 

There are few limitations on the the type of real estate you can purchase through a SDIRA. However, any real estate purchases must be made as an investment, and not for personal use. In fact, you or your family members cannot even personally stay at the property even for a vacation. This would be considered a prohibited transaction with a disqualified person, and the rules around this are extremely strict (more on this further down below).

How does a self-directed IRA work?

A self-directed IRA has the same contribution limits, eligibility requirements, and withdrawal rules as a regular IRA. The only difference is in your investment options.

With a regular IRA, your investment options are limited to traditional assets like stocks, bonds, mutual funds, and ETFs. A self-directed IRA opens the door to alternative asset classes like real estate. 

But real estate isn’t the only alternative asset you can purchase through a self-directed IRA. You can also invest in crypto, NFTs, precious metals, and even private equity. However, not all self-directed IRAs offer the same investment options. Most custodians specialize in one particular asset (like real estate).

Traditional or Roth

Depending on your retirement goals, you can choose to open a self-directed traditional IRA or a self-directed Roth IRA. A traditional IRA is funded with pre-tax dollars (income you haven’t paid taxes on yet), but you pay regular income taxes when you make withdrawals in retirement. A Roth IRA is funded with post-tax dollars (income you’ve already paid income taxes on), but withdrawals in retirement are tax-free.

Because alternative asset classes can often provide higher returns than typical traditional assets (like mutual funds), many people will opt to purchase real estate through a self-directed Roth IRA rather than a traditional IRA.

If you invest $100,000 into a property, and it grows in value to $1.1 million, with a self-directed Roth IRA, you’ll owe zero taxes when you sell the property for a profit and decide to withdraw the money from your account. Because you already paid income taxes on the $100,000, you owe nothing on the million dollars in profit.

How to buy real estate with a self-directed IRA

The IRS requires any IRA to have an IRS-approved institution that acts as the account’s custodian. To purchase and hold real estate in your IRA, you’ll need to find a self-directed IRA custodian that lets you purchase real estate. 

With a regular IRA, it’s much simpler. The custodian is simply the bank or brokerage that provides you the IRA. However, with a self-directed IRA, you have to find a third party custodian who will let you invest in the alternative asset class you want, act as the intermediary between you and your real estate investments, maintain all your records, file IRS reports, and perform various other administrative tasks.

Every and any transaction must go through your custodian

While your IRA is “self-directed,” you still need to instruct your custodian to make every transaction for you. This can be fine for set-and-forget type investments like private equity, but real estate can require a lot of mini transactions.

Whether you need to pay a plumber, replace a lightbulb, or repair a staircase, you have to formally request your custodian to send the funds. This process is not instant and can take several days, which can cause a lot of headaches if you need to urgently make a payment.

This is why, for real estate investments, a self-directed IRA with checkbook control is often the preferred choice. An SDIRA with checkbook control is the same as a regular SDIRA, but with an extra layer on top: an LLC. The IRA owns your LLC, you’re appointed as the manager of the LLC, and the LLC has its own checking account. As the manager of the LLC, you get control over the checkbook. With this method, a custodian still provides administrative duties, but you no longer have to make every transaction through them.

The Carry Solo 401k is a supercharged self-directed solo 401k plan with checkbook control. Invest in any asset class, including real estate, and contribute up to 10x more than an IRA each year. Learn more about it here.

Risks of buying real estate with a Roth IRA

Investing in real estate through a Roth IRA comes with higher risks, less liquidity, strict rules set by the IRS (and steep penalties for breaking them), and high maintenance.

Prohibited transactions

When you purchase real estate through a retirement plan, like a Roth IRA, the account is technically the owner of the house. The Roth IRA owns the property, and you own the Roth IRA. Your real estate purchase must be for investment purposes only. You, or any disqualified persons, cannot live in it or use it for personal use. You also cannot hire them for any work done on the property, rent or sell it to them, or buy it from them.

The IRS lists a disqualified person as:

  • You
  • Your spouse
  • Your lineal ascendants (parents, grandparents)
  • Your lineal descendants (children, grandchildren)
  • Spouses of your lineal descendants (son-in-law, daughter-in-law)
  • Fiduciaries (someone who makes investment decisions for your solo 401k plan)
  • Anyone who provides services to your plan (such as your accountant)
  • Highly compensated employees of your business
  • Companies where you, your spouse, or your lineal ascendants/descendants own 50% or more of the business
  • Companies where your lineal ascendants or descendants own 50% or more of the business
  • Anyone who owns more than 10% of the business
  • Officers and directors of the business

Your siblings, step-parents, step-children, friends, and relatives (like your aunt and uncle) are not considered as a disqualified person.

Pay in all cash

When purchasing real estate through your Roth IRA, you typically have to make an outright purchase with all cash. It’s difficult to get a mortgage when purchasing property through an IRA. This means that you’ll have to have a sizeable balance in your Roth IRA, and you’ll likely end up using a large chunk of it on a single investment.

All purchases for the property must be made by the Roth IRA

The Roth IRA is the technical owner of the property. Due to the disqualified persons rule we learned above, you can’t intermingle your personal funds with the Roth IRA’s real estate holdings. All ownership expenses must be paid by the Roth IRA.

This can cause issues if the balance in your Roth IRA is not high enough to cover any major unplanned repairs to the house. For example, if you only have $10,000 in your Roth IRA, but you require emergency repairs that will cost you $15,000, you’ll be forced to overcontribute to your IRA and pay overcontribution penalties to the IRS.

In addition, using your Roth IRA to pay for property expenses is a not a great use of funds within your Roth IRA. Every dollar you spend on property expenses is a dollar that can’t get invested with tax-free compounding (and tax-free withdrawals in retirement).