How to Convert Real Estate to a Self Directed IRA

The Individual Retirement Arrangement, first introduced by the Employee Retirement Income Security Act of 1974, allows for a wide range of investments. While most people invest their IRA contributions in mutual funds, annuities, stocks and bonds, you may also invest in a variety of other vehicles as well, including stock in closely-held companies and real estate. However, the IRS imposes strict limits on real estate investments within IRA accounts. It is therefore vital to enlist the services of a qualified expert to guide you through this process and avoid having the tax-deferral of your IRA investments disallowed.

• 1

  Identify a qualified custodian for your self-directed IRA. The IRS requires you to have a disinterested third party act as the custodian for any assets in a self-directed IRA. You cannot act as your own custodian. The custodian you select actually takes over the ownership interest on behalf of your IRA. Very few banks or other financial institutions allow self-directed IRAs or are willing to act as custodians except with a very limited number of investments.

• 2

  Form a Limited Liability Company in your state, or in the state in which you want to hold the assets. You will need to file articles of incorporation with the state's office of the secretary of state, and obtain an employer identification number from the IRS. You can have an attorney do this on your behalf, or you can have your custodian help you. Most custodians who specialize in self-directed IRAs will help you with this process.

• 3

  Verify that your proposed investment isn't prohibited by the IRS for the purposes of IRA investing. Generally, you can hold real estate in an IRA, but the IRA cannot purchase the investment directly from you or a closely related party, such as an immediate family member. You also cannot hold real estate in an IRA that is intended for your own personal use, either now or in the future.

• 4

  Transfer retirement assets to the self-directed IRA custodian, using a trustee-to-trustee transfer.

• 5

  Open a bank account for your Limited Liability Company. You will use this bank account to handle all transactions related to your self-directed IRA.

• 6

  Request your new custodian to transfer the funds to your LLC's bank account and purchase an ownership interest in your LLC. You will remain as manager of the LLC, directly controlling the assets in your LLC's bank account. Technically, the IRA owns the account, not you. But you are the manager and you control all transactions.

• 7

  Purchase the real estate using the funds in your IRA. All income from the investment must go to the LLC, and you must pay all expenses from the LLC. You cannot commingle personal funds with the LLC in your IRA. If you do so, the IRS may disallow the transaction, and deem the entire LLC to be a taxable distribution, subject to income tax, stripped of the benefit of tax deferral, and subject to a 10 percent penalty if you are younger than age 59 1/2.