A Step-by-Step Guide

Self-directed IRAs and Multi-family Investing

Just a year ago, I had never heard of Self-Directed IRAs (SDIRAs). Or if I had, the concept was so foreign that it didn’t even register on my radar. Like many people, I assumed that retirement accounts were limited to traditional options—stocks, bonds, mutual funds, and exchange traded funds, with some dabbling in crypto. It wasn’t until I started diving deeper into the possibility of investing in multifamily properties that I learned about the flexibility and potential of SDIRAs. These unique retirement accounts give investors complete full control over their investment choices, allowing them to invest in a wider range of assets, including multifamily real estate properties.

How can an self-directed IRA help you invest in multifamily properties?

An self-directed IRA allows you to use retirement funds to invest in multifamily properties, diversifying your portfolio and potentially increasing returns while maintaining tax advantages.

If you think you don’t have enough money available to invest in multifamily properties but have an IRA or a 401(K), you will want to understand the connection SDIRAs because the can be a great entry point into your journey of investing in multifamily properties. Multifamily properties, in particular, offer a compelling opportunity for steady cash flow back to your SDIRA along with long-term appreciation. In this blog post, I will guide you through the steps needed to leverage an SDIRA for investing in multifamily properties,, from setting up your account to navigating the rules and regulations. Whether you’re a seasoned investor or just starting out, this guide will provide the insights you need to make informed decisions about your retirement future.

What is a Self-Directed IRA?

A Self-Directed IRA (SDIRA) works a lot like a traditional IRA, but with one big twist: you get to decide where to invest your money, including investing in multifamily properties. Traditional IRAs tend to limit you to the standard choices—stocks, bonds, and mutual funds. But with an SDIRA, it’s like Doc Brown in Back to the Future saying, “Roads? Where we’re going, we don’t need… roads.” You aren’t confined to the usual paths; instead, you can explore a wider range of investments, such as real estate, precious metals, or private equity.

Using an SDIRA to invest in multifamily properties comes with some great benefits. For one, you can enjoy tax-deferred or even tax-free growth, depending on whether you opt for a traditional or Roth SDIRA. You also get to steer your own ship, choosing investments that align with your financial goals. Multifamily real estate is particularly attractive because it can offer steady cash flow and long-term growth—all within the tax-friendly environment of an SDIRA.

Why Consider Investing in Multifamily Properties with an SDIRA?

Investing in multifamily properties through an SDIRA offers the potential for higher returns (often 15%) compared to traditional stock and bond investments (traditionally 8%-9%). While the stock market can be unpredictable, real estate—especially multifamily properties—provides stability and long-term growth potential.

Multifamily real estate stands out because it offers steady, reliable cash flow from rental income. This income can grow tax-deferred (or tax-free if using a Roth SDIRA), allowing your investment to compound over time without immediate tax obligations.

Multifamily properties also come with unique advantages. For one, they’re scalable—you can invest in multiple multifamily deals around the country, reducing your exposure to regional economic fluctuations.

Additionally, economies of scale make management and maintenance more cost-effective. The ability to spread costs across multiple units enhances profitability, making multifamily properties a smart choice for income and long-term appreciation.

If you’re looking for a way to diversify your portfolio while benefiting from both income and tax advantages, investing in multifamily properties within an SDIRA is a solid option.

The Mechanics of Using an SDIRA for Investing in Multifamily Properties

If you’re ready to start investing in multifamily properties using a Self-Directed IRA (SDIRA), take the time and make the effort to understand the step-by-step process. Let’s break it down practically, so you know exactly what to do at each stage.

1. Opening a Self-Directed IRA

The first step is to select a custodian who specializes in Self-Directed IRAs. Not every financial institution offers SDIRAs, so you’ll need to choose a company that allows you to invest in alternative assets like real estate. Take the time to compare fees, services, and customer reviews. Once you’ve chosen a custodian, you’ll need to decide between a Traditional SDIRA or a Roth SDIRA. With a Traditional SDIRA, contributions are tax-deductible, but you’ll pay taxes when you withdraw in retirement. A Roth SDIRA offers tax-free withdrawals, but contributions are made with after-tax income. After deciding which option fits your situation best, your custodian will help you set up the account.

2. Funding the SDIRA

Next, you need to fund your SDIRA. You can contribute new money up to the annual limit ($6,500 for 2023, or $7,500 if you’re over 50), or you can roll over or transfer funds from an existing retirement account, like a 401(k) or traditional IRA. The rollover process allows you to move your money without paying taxes or penalties, as long as you follow IRS guidelines. This is a key way to fund your SDIRA for real estate investing, especially if you already have significant retirement savings but haven’t thought about investing them in multifamily properties. Just be mindful of contribution limits and ensure the transfer or rollover is done correctly to avoid penalties.

3. Choosing Your Investment

Once your SDIRA is funded, it’s time to choose an investment. If you have a massive SDIRA fund, you could consider buying a multifamily property on your own, but for most investors, real estate syndication can make better sense. A syndication involves a group of passive investors (limited partners) who pool their money to buy larger properties through active investors (general partners) who do the leg work of finding, analyzing, closing, and managing the deals.

Take the time to evaluate the investment, looking for multifamily deals with solid cash flow potential, reasonable expenses, and good location metrics. Whether you’re investing directly or in a syndication, make sure the deal aligns with your investment goals, whether that’s steady income, long-term appreciation, or both. Also, be sure to work closely with your custodian, as they will handle the actual transaction once you’ve selected a property.

4. Conducting Due Diligence

Before moving forward with any investment, conducting due diligence is vital. This means carefully analyzing the financials of the property or syndication. Look at the income statements, cash flow forecasts, and operating expenses. Make sure the numbers align with your expected returns. Next, have the property inspected to ensure there are no hidden issues, such as deferred maintenance or structural problems. You’ll also want to analyze the local market—are rental rates stable? Is there strong demand for housing? Are the job and population growth trends favorable? Legal and tax considerations are important too; consult professionals to ensure the investment structure meets IRS rules for SDIRAs.

5. Making the Purchase

Once you’ve chosen a syndication and completed your due diligence of the deal, it’s time to invest through your SDIRA. First, instruct your SDIRA custodian to send the funds to the syndication’s designated account, usually managed through an attorney. Make sure the syndication’s subscription agreement or other legal documentation related to the property investment are not in your personal name but in the name of your SDIRA to comply with IRS regulations.

For example, if your name is Josh Jones and you’re using SDIRA funds, the syndication’s LLC paperwork would list your SDIRA name (e.g. Summit Trust Company FBO Joshua Jones IRA) rather than identifying you personally as an LP.

The general partner will handle the property acquisition while you remain a passive investor. Your returns, whether through cash flow distributions or sale proceeds, will flow directly into your SDIRA, allowing you to continue growing your retirement funds tax-deferred or tax-free.

6. Managing the Investment

Once the purchase is complete, the property needs managing. In a syndication, the General Partner or Partners (GPs) are responsible for managing the property, handling day-to-day operations, ensuring the investment performs well, and distributing the profits. Your role as a limited partner is passive, meaning you simply monitor your investment’s performance and receive your share of income.

7. Reaping the Rewards

The beauty of using an SDIRA for real estate is how the income and profits are treated. Rental income and any eventual profits from selling the property flow back into the SDIRA. If you used a Traditional SDIRA, these earnings grow tax-deferred until you take distributions in retirement. If you have a Roth SDIRA, the income and growth are tax-free, meaning you won’t owe taxes when you withdraw the funds.

You can also choose to reinvest the returns into other properties or investments within the SDIRA, further compounding your growth. Over time, the combination of steady rental income and potential appreciation can significantly boost your retirement savings.

At this point, you have probably realized that investing in multifamily properties with an SDIRA means the profits can’t be used for immediate personal benefit—so no using them to fund a transatlantic cruise to Spain! Just like with a traditional or Roth IRA or 401(k), the profits are meant for future use, growing tax-deferred (or tax-free, in the case of a Roth) until retirement.

Navigating the Rules and Regulations of SDIRAs

When using an SDIRA to invest in multifamily properties, understanding IRS rules is key to staying compliant. One of the main regulations to watch out for involves Prohibited Transactions. These include self-dealing, where you or close family members—referred to as “disqualified persons”—personally benefit from the property. For instance, you cannot live in, vacation at, or rent the property to family members, as this would result in severe tax penalties.

Another factor to consider is Unrelated Business Income Tax (UBIT). UBIT applies when your SDIRA earns income from certain sources, like leveraging a property with a loan. The tax can impact the profitability of your investment, so it’s important to plan accordingly and consult a tax professional if UBIT is likely to apply.

Lastly, if your SDIRA is a Traditional account, you’ll need to factor in Required Minimum Distributions (RMDs). These kick in at age 73, which can be tricky with real estate holdings. Developing a strategy for how to take these distributions while maintaining your investment is essential for long-term success.

Case Study: A Successful Multifamily Investment Using an SDIRA

Let’s look at a real-world example of an investor who used an SDIRA to invest as a limited partner in a multifamily syndication. This investor, a mid-career professional with a Traditional IRA, was looking to diversify his retirement portfolio. After learning about SDIRAs, he rolled over a portion of his existing IRA into a Self-Directed IRA and partnered with a syndicator to invest in a 50-unit apartment complex.

The process began with the investor opening his SDIRA account and funding it through a tax-free rollover. He worked closely with a custodian to ensure all transactions stayed compliant. After conducting due diligence on the syndicator and the property, he committed $75,000 through his SDIRA. As a limited partner, he didn’t have to deal with day-to-day property management, which was handled by the syndication’s general partner.

While the biggest challenge was navigating the SDIRA’s rules, particularly avoiding prohibited transactions, the investment paid off. Over five years, the multifamily property generated steady cash flow, and when it sold, the investor saw significant returns—tax-deferred in his SDIRA. Key takeaways from this experience? Partnering with an experienced syndicator and understanding IRS rules are key to making the most of multifamily real estate within an SDIRA.

How to Avoid Potential Pitfalls When Investing in Multifamily Properties

New SDIRA investors often stumble when navigating the complexities of investing in multifamily properties through a syndication. One common mistake is misunderstanding prohibited transactions with SDIRAs, such as inadvertently benefiting personally from the property or working with disqualified persons (like family members). Another pitfall is mismanaging SDIRA funds, including using personal funds for property expenses, which could lead to severe penalties.

To avoid these issues, keep all investment transactions flowing through the SDIRA and ensure every expense is handled properly by the custodian. Working with SDIRA custodians who are not experienced professionals should be out of the question. Financial advisors, CPAs, and SDIRA custodians can help you navigate the specific IRS regulations governing SDIRAs. They also ensure that your investment structure stays compliant with the law.

Taking time to fully understand the rules, while also getting the right team in place, will help you avoid costly mistakes and make the most of your SDIRA investment in multifamily syndications.

Taking the First Step: How to Get Started Investing in Multifamily Properties with SDIRAs

Ready to explore investing in multifamily properties through a Self-Directed IRA? Start by selecting a reputable SDIRA custodian who can help you set up and manage your account. Building a network of trusted professionals—such as financial advisors, tax experts, and syndicators—will provide the support needed for success. For those new to real estate investing, consider starting with smaller syndication deals to gain experience before diving into larger opportunities.

But take the first step, and take it now. Waiting until later is putting it off indefinitely. Multifamily properties offer steady income and long-term appreciation, making them an excellent option for retirement investing. Don’t hesitate to learn more, ask questions, and get involved in the process. If you’re serious about exploring multifamily syndications with a Self-directed Individual Retirement Account, TAWC Properties offers consulting and education to help you understand the process, make informed decisions, and connect with experienced custodians. Reach out today to gain the knowledge and confidence you need to start your SDIRA multifamily property investment journey!

Related Questions

1. When is a Roth Self-directed IRA better than a Traditional Self-directed IRA?

A Roth Self-directed IRA is preferable if you expect to be in a higher tax bracket during retirement, as withdrawals are tax-free. It’s also ideal if you want tax-free growth and don’t need immediate tax deductions.

2. What are the tax implications of investing in real estate with an SDIRA?

Real estate investments in an SDIRA grow tax-deferred (Traditional) or tax-free (Roth). However, investors may be subject to Unrelated Business Income Tax (UBIT) if their SDIRA uses leverage or certain types of income are earned.

3. How do I avoid prohibited transactions with my SDIRA investments?

Avoid engaging in self-dealing, working with disqualified persons (e.g., family members), or personally benefiting from SDIRA assets. All transactions must be handled through the SDIRA custodian to stay compliant with IRS regulations.