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  • Writer's pictureIan Ippolito

How to Liberate Your IRA to Invest in Real Estate

Updated: Sep 20, 2023

Quick guide on self-directed IRAs and solo 401(k)s. And what to watch out for..

How to Liberate Your IRA to Invest in Real Estate

(Usual warning: I'm just an investor and not an accountant, financial advisor, tax advisor or attorney. This is my opinion only, and you should consult your own financial and legal professionals before taking any action on this or other financial matters.)

Many investors have money in IRA retirement accounts that they want to invest in alternative investments, like real estate crowdfunding and syndications. But typically, they can't because most IRA custodians lock down their available options to just the investments that they sell.

Thankfully, there IS a way to free your IRA. And there are some pitfalls to watch out for,too. So here's a guide to get you started. (And as always, consult with your financial and legal advisors first, to make sure any solution meets your personal needs).

First things first

First, your money needs to be in an IRA (which you control) versus your employer 401(k) retirement plan (which your employer controls and will typically limit what you can invest in). All set there? Okay, good…

Breaking free

Typically people might have an IRA account at a bank or with a brokerage firm. They aren't going to let you invest that in real estate, because they want to hold it captive to their own products.

So the 1st thing you have to do his move it into an account you control. You have 2 choices: a self-directed IRA and what's called a "solo 401(k) with checkbook control".

The self-directed IRA has the advantage of being the easiest to qualify for (anyone can do it). The downside is that it could subject you to certain types of taxes (UBIT/UDFI) that you have to watch out for.

A solo 401(k) with checkbook control, generally allows you to avoid those taxes. but not everyone can take full advantage. If you have a legitimate side business, you're in the best shape, because you can set up a solo 401(k) and add to it every year from your business income. If you're a typical W-2 employee without a legitimate side business, you can't add money to one. However, if you have a non-roth IRA, the IRS currently lets you roll that into a solo 401(k). Again, you still can't put any new money into it, but that still allows you to take advantage of the perks discussed below. Also, some employers allow 401(k) holders to do a partial rollover into a solo 401(k). Check with your employer. One downside is that you still have to be extra vigilant about what you do with it, to make sure you don't accidentally lose your tax exempt status. So it's a more sophisticated structure, but only recommended for more sophisticated investors.

Most people will go with the self-directed IRA, so let's talk about that first.

Self-directed IRA

By transferring your IRA to a self-directed IRA company, you gain the ability to invest in things beyond banks and brokerages, like real estate. You typically pay a set up fee and then a yearly fee of about $100-$200. The company handles everything else. Many people find it a small price to pay for the freedom to access the investments they want to be in.

Here are a couple of popular, lower cost services:

The freedom is fantastic, but along with this freedom comes some potential things to watch out for.

No shoes, no shirt, no service?

Some sponsors will not accept a self-directed IRA (or a solo 401(k)) because it does mean extra paperwork for them. Or a few may not accept the company you've selected as your custodian for whatever reason. So it's always important to check first, before spending too much time on doing other due diligence. Why did my tax-free account just get taxed?

Some people investing through a self-directed IRA get hit with a nasty surprise. Due to IRS rules, you have to be careful to not trigger something called Unrelated Business Income Tax (UBIT)... or its ugly relative Unrelated Debt Financing Tax (UDFT). If you're not careful, you can get taxed anywhere from a hefty 15% to an almost unbelievable 39.6%. So you want to make sure you avoid it whenever possible.

How does UBIT/UDFI happen?

The main thing to look for is if the fund is using leverage (borrowed money) to increase profits. (Raw interest, dividend income and rental income are usually exempt from UBIT). If it uses leverage, it may potentially get hit with UBIT. (Technically UDFI which is taxed under UBIT rates). Not all leveraged funds get hit by this tax. The rules for figuring this out are pretty complex, and depend how the investment is structured and pays out. And even if you do get hit with UBIT/UDFI, the 1st $1000 is usually not taxable. So it may or may not matter.

So bottom line is that you should always check with the investment sponsor before you invest (and your own advisors). Also, it's important to check both UBIT AND UDFI. (I've read even blogs from attorneys that only mention UBIT, which is only half the job and can still lead to a nasty surprise).

Buying debt versus using debt

It's important to understand that a fund that invests in debt (i.e. purchases and owns debt) doesn't trigger a potential UDFI tax. The fund itself has to have debt of its own (owed to and owned by a 3rd party) to do it.

So for example, a hard money loan fund without leverage like Arixa Secured Income or BroadMark, won't trigger UDFI. Many crowdfunding platforms like PeerStreet and FundThatFlip can be the same. But any leveraged investment potentially will. Again, it's important to check first with the fund/platform to find out what their situation is.

And actually, many investors like/prefer investing in nonleveraged debt funds in their self-directed IRA, because it has another tax benefit.

Equity/debt tax strategies:

Many investors with limited IRA funds have a rule: "save your IRA for non-leveraged debt investments". Here's why.

First, almost every equity fund has leverage. So that usually is a non-starter with the UBIT/UDFI penalty. Second, most equity investments have considerable depreciation, which shields your yearly earnings from taxes. (True, there's no such thing as a free lunch from the IRS. So when the fund closes and sells off all the properties, you have to pay it back. But many funds can take years to close, so many investors consider this to be a nice perk).

To take advantage of this, you need to be investing with taxable dollars. If you put this equity investment into your IRA, you're "wasting" the tax-benefit from depreciation.

On the other hand, if you put your debt investment in your IRA, it doesn't have the tax savings of depreciation, and thus makes fuller use of the tax savings power of your IRA itself.

What about converting into a solo 401(k)?

If you want to avoid having to deal with UBIT/UDFI entirely, then a solo 401(k) with checkbook control may be your best option. This frees you up to invest in many leveraged funds that would have penalized you before. And since most equity funds have leverage, this frees the investor to invest in these, and not have to pay capital gains at the end. As I mentioned above, if you're a W-2 employee without a legitimate site business, you can only do this with a non-Roth IRA or if your employer allows you to do a partial 401(k) rollover. But if you can swing it, then it may be a good option for you.

Again, consult with your team of financial professionals 1st, because the freedom of the solo 401(k) can be dangerous. If you're not careful, you might be tempted to invest in something that could cause you to lose your tax exempt status and/or get hit with penalties.

Here are a couple of solo 401(k) providers:

What are the limitations and is there a better way? In part two of this article, I talk about some of the limitations of IRAs/solo 401(k)'s, and why you may other options that may work better for certain parts of your portfolio.

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About Ian Ippolito
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Ian Ippolito is an investor and serial entrepreneur. He has been interviewed by the Wall Street Journal, Business Week, Forbes, TIME, Fast Company, TechCrunch, CBS News, FOX News, USA Today, Bloomberg News,, CoStar News, Curbed and more.


Ian was impressed by the potential of real estate crowdfunding, but frustrated by the lack of quality site reviews and investment analysis. He created The Real Estate Crowdfunding Review to fill that gap.

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