Which Types of IRAs Can Be Used to Invest in Commercial Real Estate?


Key Takeaways

Key Takeaways

  • An Individual Retirement Account or “IRA” is a specialized type of savings account that allows investors to save for retirement with tax-deferred or tax free growth.
  • Broadly, IRAs can be divided into two types: self-managed and self-directed.
  • A self-managed IRA is opened with a broker or financial advisor and the account holder’s investment options are typically limited to traditional investments like stocks and bonds.

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Traditional retirement advice directs individuals to open a tax-advantaged retirement account, and to invest a little bit of money each week or each month in a diversified portfolio of stocks and bonds so that the funds can grow over time. The advice is sound, but stocks and bonds aren’t the only investment options available. Depending on the type of individual retirement account, funds can be used to invest in commercial real estate assets, which can add another element of diversification to the traditional stock/bond portfolio.

In order to understand how this process works, it is first necessary to understand what an individual retirement account is, and how such accounts can be used to build wealth over time.

What is an Individual Retirement Account?

An individual retirement account or “IRA” for short, is a specialized type of savings/investment account that allows its owner to save for retirement with tax-free or tax-deferred investment growth. Broadly, IRAs can be divided into two types: self-managed and self-directed IRA.

A self-managed IRA is the most common type, and it is opened with a financial institution or broker who manages the account. The account owner has the freedom to choose how the account funds are invested, but they may be limited to a handful of options allowed by the manager. Typically these options include stocks, bonds, mutual funds, and some types of exchange traded funds or ETFs.  

A self-directed IRA serves a similar purpose, but it is opened with an IRA Custodian and the number of available investment options is much more diverse. Funds can be invested in traditional assets like stocks and bonds, but they can also be used for alternative assets like:

  • Promissory Notes and tax liens 
  • Gold, silver, precious metals, and cryptocurrency 
  • LLC membership interests 
  • Commercial real estate, including raw land

For those looking to invest IRA funds in commercial properties, the simple answer is that this can be accomplished through a self-directed IRA. However, these accounts can be tricky to set up and must follow a series of rules established by the IRS to maintain their tax advantaged status.

Self-Directed IRA Rules

While one should always study the fine print carefully, there are five primary rules for self-directed IRAs:

  • Type: Self-directed IRAs can be a traditional IRA or a Roth IRA. The account can be a “traditional” IRA where funds are deposited pre-tax and grow tax-deferred over time. Withdrawals can begin at age 59.5 and are taxed as current income at the then-prevailing rate. Or, it can be a “Roth IRA” where funds are deposited after tax and allowed to grow tax free. Withdrawals can also begin at 59.5, but are tax free.
  • Contribution Limits: Self-directed IRA contributions are subject to limits. They change periodically, but in 2020 they were $6,000 for individuals under the age of 50 and $7,000 for those over 50. The tax deductions available for contributions may be subject to income limits.
  • Custodians: Self-Directed IRAs must be set up with a custodian. According to IRS Publication 590-A, the trustee or custodian must be a bank, a federally insured credit union, a savings and loan association, or an entity approved by the IRS to act as trustee or custodian. The trustee or custodian generally can’t accept contributions of more than the deductible amount for the year. However, rollover contributions and employer contributions can be more than this amount.
  • Prohibited Investments: While the number of self-directed IRA investment options is greater than those available in a self-managed account, there are still several that are prohibited. They are also outlined in IRS Publication 590-A and they include: artwork, rugs, antiques, gems, stamps, coins, alcohol, and other tangible property.
  • Prohibited Transactions: In addition to prohibited investments, there are also a number of transaction types that are prohibited with self-directed IRAs. They include the transfer or use of IRA assets by or for the benefit of a disqualified person, excess contributions, early distributions, and the accumulation of excess amounts.

For those willing to abide by these rules and wanting to pursue commercial real estate investment with their self-directed IRA, an account can be opened in three steps.

How to Open a Self-Directed IRA

The first step to opening a self-directed IRA is to find a custodian. Again, this could be a bank, credit union, savings and loan, or other entity approved by the IRS. In many cases, the easiest way to find a custodian is through a simple internet search or with a recommendation from a trusted financial advisor.

Once a custodian has been found, the next step is to work with them to open the account. Self-directed IRAs can be more difficult to open than a self-managed IRA and they often involve a significant amount of paperwork. As such, it is a best practice to be prepared with the necessary information and to allocate the time needed to complete the process.

Once the IRA account is open, it is necessary to fund it. Aside from the initial deposit, it is important to reiterate that account contributions are subject to annual limits and it is important to abide by them. With retirement funds available to invest, there are additional steps that the account holder needs to take to purchase his or her first investment property.

Using an IRA to Invest in Commercial Real Estate Assets

Using self-directed IRA to invest in real estate is not as simple as using non-IRA funds. However, it can be done in four steps:

  1. Find the Investment: The first step is to find a property or investment opportunity. Self-Directed IRA rules allow for either the direct purchase of a property or the acquisition of LLC membership interests, such as those offered in a private equity investment vehicle. In the latter scenario, it is important to work with an experienced private equity sponsor who has knowledge of how to handle self-directed IRA funds.
  2. Commit to the Investment: Once a suitable investment has been identified, the next step is to commit to it. In the case of a direct real estate purchase, this means placing the property under contract. In an indirect investment scenario, it means working with the transaction sponsor to complete the needed documentation (like the subscription agreement) to formally commit capital to the investment.
  3. Complete Due Diligence: In a direct investment, the purchase and sale agreement should allocate a specific amount of time to complete due diligence on the property to ensure it is as advertised. This includes reviewing property surveys and environmental reports in addition to analyzing the property’s financial records.
  4. Communicate the Investment to the IRA Custodian: When property and/or sponsor due diligence has been completed, the last step is to communicate the specifics of the transaction to the custodian. The specifics include how much money is needed, what documentation is required, and where to send the funds. Investment funds can be used to purchase the entire property or a portion of it. The self-directed IRA custodian will handle the transfer of funds on the real estate investor’s behalf.

Once the rental property is acquired and or the investment is complete, the owner has the potential to realize all of the same benefits as a non-SDIRA investment, including: stable rental income and cash flow, the tax benefits associated with depreciation, and the potential capital appreciation of the asset.

Interested In Learning More?

First National Realty Partners is one of the country’s leading private equity commercial real estate investment firms. With an intentional focus on finding world-class, multi-tenanted assets well below intrinsic value, we seek to create superior long-term, risk-adjusted returns for our investors while creating strong economic assets for the communities we invest in.

To learn more about our real estate investing opportunities, including qualifying opportunity zone investments, contact us at (800) 605-4966 or info@fnrpusa.com for more information.


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