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Investing in real estate and other alternative assets through tax-advantaged retirement accounts, such as Self-Directed IRAs (SDIRAs) and Solo 401(k)s, can be a powerful wealth-building strategy. These investment vehicles allow for diversification beyond traditional stocks and bonds, offering access to real estate, private equity, private credit, cryptocurrency, precious metals, and more.
This guide provides a detailed breakdown of how to use these accounts, the benefits and risks involved, the steps to fund investments, and critical tax considerations—including the impact of Unrelated Business Income Tax (UBIT).
1. Self-Directed IRA (SDIRA)
A Self-Directed IRA (SDIRA) operates similarly to a traditional or Roth IRA but allows investments in non-traditional assets, such as:
✔ Tax Advantages – Tax-deferred (Traditional SDIRA) or tax-free growth (Roth SDIRA).
✔ Diversification – Access to alternative investments outside the stock market.
✔ Potential for Higher Returns – Real estate and private market investments can outperform traditional assets over time.
✔ Asset Control – You select the investments instead of relying on a fund manager.
✖ Prohibited Transactions – The IRS restricts self-dealing, such as investing in property you personally use.
✖ UBIT/UBTI Taxes – Certain investments generate Unrelated Business Income Tax (UBIT), reducing tax efficiency.
✖ Custodian Requirement – You must use an approved SDIRA custodian, which may result in higher administrative fees.
✖ Limited Liquidity – Real estate and private investments may be illiquid, restricting quick access to funds.
2. Solo 401(k)
A Solo 401(k) is an employer-sponsored plan designed for self-employed individuals or business owners without full-time employees (other than a spouse). It offers the flexibility to invest in real estate and other alternative assets, much like an SDIRA.
✔ Higher Contribution Limits – Can contribute up to $69,000 (or $76,500 if age 50+) in 2024, far exceeding IRA limits.
✔ Loan Option – Borrow up to $50,000 or 50% of the account balance, whichever is less.
✔ Avoids UBIT on Leveraged Real Estate – Unlike SDIRAs, a Solo 401(k) exempts real estate investments from UBIT when using debt financing.
✔ Checkbook Control Option – No custodian required when structured properly, offering faster transactions.
✖ Requires a Business Entity – Only available to self-employed individuals or small business owners without employees.
✖ Strict Administrative Requirements – IRS requires a 5500-EZ filing once assets exceed $250,000.
✖ Potential Complexity – More setup and ongoing maintenance compared to an IRA.
The following is a list of firms that we and our investors have experience with. However, investors should conduct their own due diligence, as Hearthfire Holdings has no affiliation with or financial interest in these providers.
Self-Directed IRA Custodians & Solo 401(k) Administrators
Self-Directed IRA: The IRA, not the investor, must be named on the title and sign legal documents. Example:
“XYZ Custodian FBO [Your Name] IRA”
Solo 401(k) with Checkbook Control: The investment is made via the 401(k) trust directly.
Work with legal and tax professionals to ensure compliance and mitigate risk.
Unrelated Business Income Tax (UBIT) applies when tax-exempt entities, like SDIRAs, earn income from a business or leveraged real estate investment.
✔ Use a Solo 401(k) Instead of an SDIRA – Solo 401(k)s are exempt from UBIT on leveraged real estate.
✔ Invest in Debt-Free Assets – UBIT applies only when leverage is used.
✔ Consider a Roth IRA/401(k) – UBIT still applies, but future gains can be tax-free.
✔ Hold Investments Long-Term – If no leverage is involved, tax advantages remain intact.
✔ Use an IRA-Owned LLC (Checkbook IRA) – While not eliminating UBIT, this structure can provide operational efficiencies.
Investing in real estate and alternative assets through an SDIRA or Solo 401(k) can be a game-changer for wealth building. However, understanding the rules, tax implications, and potential pitfalls is crucial for success.
We encourage all investors to consult with qualified tax, legal, and financial professionals before making decisions. If you’d like to discuss potential investment opportunities that fit within your self-directed retirement strategy, reach out to our team for more information.
Disclaimer: This material is for informational purposes only and does not constitute tax, legal, or investment advice. The strategies and benefits discussed may not apply to every investor’s situation. You should consult with a qualified financial advisor to determine how these strategies may impact your individual circumstances.
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