A lot of investors have more money in retirement accounts than in taxable brokerage accounts. So one of the most common questions we hear is whether retirement money can go into a private real estate deal. Often the answer is yes, through a self-directed IRA or a Solo 401(k). There are rules to follow, though, and a few tax issues are easy to miss.
This guide explains how it generally works and what to discuss with your custodian and tax advisor. It is general education only, not tax, legal, or investment advice. Retirement-account rules are detailed and depend on your situation, so please work through any decision with a qualified tax professional.
What a self-directed IRA is
A self-directed IRA is a regular IRA, traditional or Roth, held by a custodian that allows alternative assets. Those can include real estate and private placement securities, along with other assets most brokerage IRAs do not support (Investor.gov, Self-Directed IRAs and the Risk of Fraud).
When an IRA invests in a syndication, the IRA itself is the investor. The custodian signs the subscription documents on behalf of the account and wires the funds from the IRA. Distributions from the deal go back into the IRA, not to you personally.
What your custodian does and does not do
This is the point people most often misunderstand. An alert published jointly by the SEC, NASAA, and FINRA explains that self-directed IRA custodians typically do not investigate the investments in the account or the background of the person promoting them, and usually do not check the accuracy of the financial information provided. Using a legitimate custodian does not make an investment legitimate (Investor.gov). Your own diligence on the sponsor still matters just as much. Our guide on how to vet a syndication sponsor covers the questions worth asking.
The IRS publishes a list of approved nonbank trustees and custodians, which is one way to check a custodian that is not a bank (IRS, Approved Nonbank Trustees and Custodians). The alert notes that the list is not complete, so a custodian that does not appear on it deserves additional research.
What a Solo 401(k) is
A Solo 401(k), which the IRS calls a one-participant 401(k), is a traditional 401(k) plan covering a business owner with no employees, or the owner and a spouse. It follows the same rules as any other 401(k) plan (IRS, One-Participant 401(k) Plans). If you have self-employment income, it can be another way to hold alternative investments, as long as the plan documents allow them. One difference from an IRA matters for leveraged real estate, and we cover it below.
The rules that matter most
Prohibited transactions
The IRS prohibits certain transactions between an IRA and "disqualified persons," a group that includes you, your fiduciaries, and members of your family, meaning your spouse, ancestors, lineal descendants, and their spouses. Examples include borrowing money from the IRA, selling property to it, using it as security for a loan, and buying property for personal use with IRA funds (IRS, Retirement Topics: Prohibited Transactions).
The consequences can be severe. Generally, if an IRA owner engages in a prohibited transaction, the account stops being an IRA as of the first day of that year, and it is treated as if all of its assets were distributed at fair market value (IRS). The IRS also notes that the risk of a prohibited transaction may be higher when an IRA holds nonpublicly traded assets or assets you directly control (IRS, Publication 590-A).
For a passive investor in a syndication run by an unrelated sponsor, the main point is simple. Keep the investment at arm's length. Do not borrow from the IRA, lend to it, or pledge it as security, do not use the property yourself, and ask your custodian and advisor before doing anything unusual.
Unrelated business taxable income (UBTI)
Retirement accounts are generally tax-advantaged, but they can still owe tax on certain kinds of income. IRAs, including Roth IRAs, are subject to the tax on unrelated business income (IRS, Publication 598). This includes income from a trade or business regularly carried on by a partnership the IRA belongs to, and the partnership reports the IRA's share on a Schedule K-1.
Rent from real property is generally excluded from UBTI. That is helpful, but it leads to the next issue.
Debt-financed income (UDFI)
Most apartment syndications use a mortgage. Under the IRS rules for debt-financed property, income that would otherwise be excluded, such as rent, can become taxable unrelated business income to the extent the property is financed with debt. The amount included is proportionate to the debt on the property (IRS, Publication 598). Gains on a sale can be affected as well.
In plain terms, an IRA that invests in a leveraged real estate deal may owe some tax inside the account, even though the IRA itself never borrowed anything. If an IRA has $1,000 or more of gross income from unrelated business activity in a year, the IRA trustee must file Form 990-T (IRS, Publication 590-A; IRS, About Form 990-T). Depreciation and other deductions can affect how much, if anything, is actually owed. That depends on the specific deal, which is exactly why a tax advisor should review it.
Where a Solo 401(k) can differ
Publication 598 explains that, in general, debt a "qualified organization" incurs to acquire or improve real property is not treated as acquisition indebtedness for these rules, and a qualified retirement plan under section 401(a) is one of those organizations. IRAs are not on that list. The exception has conditions, including special rules for real estate held through partnerships (IRS, Publication 598). So a Solo 401(k) may be treated differently from an IRA on a leveraged deal. Whether it applies to a particular investment is a question for your tax advisor.
Liquidity and required distributions
Private real estate is illiquid. Investor.gov notes that alternative assets in a self-directed IRA can be hard to sell when you want to, including when you retire or need to take required minimum distributions (Investor.gov). Before you invest retirement money in a deal with a multi-year hold, think through when you might need distributions and whether you have other assets to cover them.
A practical checklist
If you are considering using retirement funds for a syndication, here is a sensible order of operations:
Talk with your tax advisor first. Ask about prohibited transactions, UBTI, debt-financed income, and whether an IRA or Solo 401(k) fits your situation better.
Choose a custodian that handles private placements. Ask about fees, how they process subscription documents and wires, and how long it takes.
Confirm the offering accepts retirement accounts. Ask the sponsor early, since timing and paperwork can be tighter than with a personal account.
Do your diligence on the sponsor. The custodian will not do it for you.
Plan for K-1s and possible Form 990-T filings. Ask the sponsor when K-1s are usually delivered, and ask your advisor who will handle any filing.
Think about liquidity. Make sure the hold period fits your timeline and any required distributions.
How it works with Veritas
Many of our investors ask about using a self-directed IRA or Solo 401(k). Often it is possible when your custodian can work with a private placement, and we have worked with more than one custodian. We do not provide tax advice, so we always encourage investors to involve their own tax advisor. Our FAQ covers this briefly, and our invest page explains the steps to invest.
Veritas Equity Partners is a Kirkland-based owner-operator. We buy 30 to 100 unit workforce apartment communities built in the 1960s to 1990s in Pierce and Snohomish Counties. We finance with long-term, fixed-rate agency or bank debt and do not use bridge or floating-rate loans. Because our deals use mortgage debt, the debt-financed income rules above are worth reviewing with your advisor before investing through an IRA. You can read more about our approach on our strategy page and see what we own on our portfolio page.
Over sixteen years we have closed 21 deals and acquired 468 units, with no realized losses on any deal.
Talk it through
If you are thinking about putting retirement money into private real estate, we are happy to walk through how our offerings work with custodians, so you can bring good questions to your tax advisor. There is no obligation in a first conversation. Book a Discovery Call and we will go through it together.
This article is general education and is not tax, legal, or investment advice. Please consult a qualified tax advisor about your own situation.
This website is for informational purposes only. It is not an offer to sell, or a solicitation of an offer to buy, securities. Any offering is made only through official offering documents, and only to investors who meet the requirements of that offering. Past performance does not guarantee future results. Investing in real estate involves risk, including the possible loss of capital.
Sources cited
Investor.gov (SEC, NASAA, and FINRA), "Investor Alert: Self-Directed IRAs and the Risk of Fraud" (custodian role, nonbank custodian list caveat, liquidity and required minimum distributions, complex tax rules): https://www.investor.gov/introduction-investing/general-resources/news-alerts/alerts-bulletins/investor-alerts/investor-14
Internal Revenue Service, "Approved Nonbank Trustees and Custodians": https://www.irs.gov/retirement-plans/approved-nonbank-trustees-and-custodians
Internal Revenue Service, "One-Participant 401(k) Plans": https://www.irs.gov/retirement-plans/one-participant-401k-plans
Internal Revenue Service, "Retirement Topics: Prohibited Transactions" (disqualified persons, examples, effect on an IRA): https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-prohibited-transactions
Internal Revenue Service, Publication 590-A, Contributions to Individual Retirement Arrangements (prohibited transactions, nonpublicly traded assets, unrelated business income and Form 990-T threshold): https://www.irs.gov/publications/p590a
Internal Revenue Service, Publication 598 (03/2021), Tax on Unrelated Business Income of Exempt Organizations (IRAs subject to the tax, partnership income, rent exclusion, debt-financed property, real property debts of qualified organizations): https://www.irs.gov/publications/p598
Internal Revenue Service, "About Form 990-T, Exempt Organization Business Income Tax Return": https://www.irs.gov/forms-pubs/about-form-990-t