If you’re the kind of person who’s casually browsing self-directed IRA articles online, then you probably already know that you can save money for retirement with a Roth IRA. It’s an excellent tool for your investments because of the tax benefits. However, did you know that you can also buy real estate and lend money out of your Roth IRA?
Buying Properties within a Roth IRA
It is entirely possible to purchase a property using the money from your IRA. The big catch is that it must be an investment property. You cannot use the home for yourself or your family, and expenses for the property must also be paid through the IRA. While you can only put so much money into the IRA per year (6,500 – 7,500 for an individual for 2023, depending on your age and earned income), there is no cap on the amount of money you can earn tax-free within your Roth IRA. This idea is so important that I’m going to repeat it.
There is no cap on the amount of money that you can earn tax-free within your Roth IRA.
This is incredible once you fully understand it. Yes, some conditions apply. However, this means that you can buy a property using your IRA, and not pay taxes on any profit earned from the rent or sale of that property.
Property prices have risen dramatically in recent years, so few people will be able to afford to purchase a house using IRA funds. However, even if you don’t have the cash in your account to purchase a property outright, you can still use partnerships to make this possible. You can even partner with yourself! There are so many options for this, including other people, other IRAs, and even an LLC.
Now let’s take a look at the amount of money you would save by purchasing a property within your Roth IRA. For example, let’s say that you buy a rental property for $300,000. You keep the property for 7 years, then sell it for $450,000.
Original purchase price in 2015: $300,000
Sales price in 2023: $450,000
Total Profit from sale: $150,000
If you purchased the property using more traditional methods, you would pay thousands of dollars in taxes. The amount of capital gains depends on the state, so let’s look at three examples below.
| Total Profit from sale of investment property | Net Profit after capital gains taxes | Additional earnings by using Roth IRA | |
| Orlando, FL | $150,000 | $126,550 | $23,450 |
| Boston, MA | $150,000 | $118,750 | $31,250 |
| San Francisco, CA | $150,000 | $112,000 | $37,400 |
*Numbers generated using a capital gains calculator and assuming a taxable income of $75,000 annually*
If you purchased that house within the Roth IRA, you would keep the entire profit of $150,000 regardless of location or personal income.
In each case, you will save thousands of dollars in taxes, and those savings increase with the amount of profit. Remember that this is just the money from the sale of the house. Any rental income from a house purchased within your Roth IRA would be tax-free, too. Keep in mind that it will probably be needed for maintenance and other expenses since those fees will be paid out of the Roth IRA too. While there are clear risks, this can be an incredible investment tool when used properly.
Lending Money within a Roth IRA
Besides purchasing property within a Roth IRA, you can also use it to lend money to finance real estate. In other words, you hold the note instead of the property. The real estate is the collateral, like with any other lender. Since you’re the lender, you decide on the terms.
You can even become a hard money lender. Hard money is a short-term loan with a higher interest rate and fees that is typically used to fix up and flip a property. In other words, it’s a short-term interim loan. The length of the loan is usually no longer than 12 months, though you can set up the terms however you like.
It’s important to be aware of the risks involved. Like any loan with property as collateral, if the buyer doesn’t pay, you may end up with the property. Be prepared for that. However, this risk can be minimized by capping the amount of money lent out vs. the value of the property (loan-to-value ratio, or LTV).
For example, if you lend $150,000 on a property that is valued at $200,000, then your LTV is 75%. However, if that property needed a lot of maintenance, but after making those repairs, the projected value is $300,000, then your LTV is actually 50%. This is subject to the repairs being completed, of course. How will you know the value of the property? Like any lender, you should ask for an appraiser from your buyer. If it’s a fixer-upper, then the buyer should also provide a repair estimate from a licensed contractor. That way, you can look at the numbers to decide if you’re comfortable with them.
There are many reasons a person may be interested in a hard money loan. They may want access to funds quickly. The length of the closing process is usually due to the requirements of the lender, so if you’re the lender, it could go a lot faster. The buyer also may have several projects going on at once. That can lead to an investor having a high debt-to-income ratio, which means traditional lenders will not want to finance the property.
As with any investment, do your research before proceeding with these types of investment opportunities. There are many resources available to get you started such as finding a local REIA group, an association dedicated to the education of real estate investors. It is also a good place to find people looking for these kinds of deals. You can even partner with other self-directed Roth IRAs to pool money together for lending.
These deals can get a little complicated, and not all lawyers or title companies understand how to facilitate this process. Make sure that you get recommendations for a good real estate lawyer who understands more than just traditional real estate deals. Also, you will need a good tax advisor who understands these kinds of investments. Finally, be clear about the laws before proceeding, because some investments are prohibited, such as self-dealing. This just means that you can’t lend yourself money on a property that you own.
Finally, understand that you cannot do these deals with all IRA companies. You’ll need to look for a self-directed IRA company that will encourage you to be a little more creative. Make sure you fully understand what you’re doing before committing your money this way. Do your due diligence. If you do, this can be an incredible investment opportunity.
