Investing in real estate can be a wise move that nets you far more earnings than common market assets. The right property can yield long-term passive income or large capital gains, boosting your retirement wealth. If property investments have piqued your interest and you’re self-employed or a small business owner, a SEP IRA real estate approach may be the perfect fit.  

What Is a SEP IRA?

A Simplified Employee Pension (SEP) IRA is a retirement account designed for small business owners and self-employed individuals. It allows business owners to make tax-deductible contributions to their own IRA as accounts set up for their employees. 

SEP IRAs are easy to form, have low administrative costs, and don’t have filing requirements for employers. As such, they are particularly attractive if you are looking for an easy-to-manage, cost-effective retirement plan for yourself and/or your employees. 

Real Estate Investment Options with a SEP IRA

Like other types of IRAs, a SEP IRA can be designated as self-directed, which allows you to invest in real estate and other alternative assets, like precious metals and cryptocurrency.  Real estate investments can take on many forms, including those listed below: 

1. Rental Properties

Purchasing and renting out or leasing a residential or commercial property can lead to passive, regular income that goes directly to your retirement account. Once earnings enter your account, they can earn interest and grow tax-free until withdrawn.

2. Fix and Flips 

Some investment properties are more lucrative when renovated and sold.  Flipping property with a SEP IRA can lead to significant capital gains. Since the earnings go back into the account as a lump sum, your buying power increases, and you can further invest in real estate opportunities if you choose. 

3. Land

Real estate investment isn’t limited to physical structures like homes and office buildings. You can also use your self-directed SEP IRA to invest in land. Investment opportunities include residential, commercial, industrial, recreational, and raw or undeveloped land. 

4. Short-Term Rentals

Short-term rentals, including those commonly found on sites like Airbnb and VRBO, can also present lucrative real estate investment opportunities.  Like traditional rental opportunities, short-term and vacation-style rentals can result in an ongoing stream of income that will lead to a robust retirement account. 

5. Syndication

A syndication is a group of investors that pool together funds to purchase large-scale properties, such as commercial complexes. By investing via a syndicate, you can tap into the growth potential of larger properties without the capital you’d need if you were the sole investor. 

6. Wholesaling

Ideal for anyone with in-depth real estate knowledge, wholesaling is when an investor purchases a property and then sells the contract to a buyer, typically for a higher amount. This short-term investment opportunity is geared towards properties that are in distress or off-market, allowing the wholesaler to purchase at a low price. 

7. Real Estate Investment Trusts (REITs). 

 A REIT is an entity that owns and operates or otherwise invests in income-earning properties. The properties are often substantial in size and value and include office buildings, large apartment buildings, or commercial plazas, and shopping malls.  REITs offer higher earning potential and often offer more liquidity than direct real estate investment. 

When you invest in a REIT, you aren’t taking ownership of a property and thus don’t have to worry about buying a property outright. As such a REIT can be a good fit if you want to invest in real estate but don’t have the capital required or aren’t interested in the administrative logistics of ownership.

8. Tax Liens

Like REITs, tax liens are another way to invest in real estate without directly purchasing property. 

A tax lien is placed on a property when the owners default on their tax obligations. You can purchase the liens at auctions. Once you buy the lien, the property owner remits payment to you instead of the government entity that placed the lien.  Liens are commonly worth more than the auction price, and if the property owners fail to pay it, the lien holder can foreclose on and acquire the property.  

9. Mortgage Notes

Another way to invest in real estate without purchasing property is to buy a mortgage note.  After purchase, the borrower makes payment (with interest) to you instead of the original lender. 

Mortgage notes can be “performing,” meaning the borrower is current on their mortgage and actively making payments, or “non-performing,” wherein the property owner has become delinquent on their payments.  

Like tax liens, the investor can foreclose on the property if a property owner fails to meet their payment obligations.

Pros and Cons of SEP IRA Real Estate Investing

Before opening an account, you should consider several pros and cons of investing in real estate with your SEP IRA.

Pros 

• Increased earnings potential. Real estate investments often lead to higher earnings than other investment options, such as a standard collection of stocks, bonds, and mutual funds.  
• Portfolio diversification. Real estate is considered less volatile during market struggles, making it a solid foundation when paired with other assets.  When you diversify your portfolio with real estate, you can hedge against market volatility.
• Tax advantages. Earnings from a real estate investment can grow tax-free while in your SEP IRA. If you have a Traditional account, taxes are paid when you withdraw, while earnings in Roth-designated accounts are taxed upfront and can be withdrawn tax-free upon retirement. In addition, if you contribute to employee accounts, you can deduct those contributions come tax time. 
• Enhanced control. If you invest in real estate, you’re in charge of the property, including how it fits into your long-term strategy.  You can rent or lease your property if you want to establish passive income that can provide continual earnings. If you want to fix and flip a property and then move on to invest in a new one, a SEP IRA will allow for it. 
• Higher contribution limits.  The most recent SEP IRA contribution limit is 25% of an employee’s salary or $69,000 per year, whichever is the lesser. Contributions to a standard IRA are limited to $7,000 ($8,000 if you’re 50 or older). 

Cons

• Complex rules and regulations. The IRS has strict rules for investing SEP IRAs, dictating several aspects of the account and investments it holds, including who can directly engage with the property transaction, how you can pay for things like repairs and renovations, and how earnings are transferred back to the account.  
• Less liquidity. Though some real estate-based investments, like REITs, can offer liquidity, real estate generally is less liquid than other assets. For instance, if you purchase a residential property with your SEP IRA, you’ll need to sell the property to gain liquidity.
• Investment risks.  Even though real estate is notably less volatile than market-based assets, there is still risk. For instance, a property may depreciate or it may be difficult to find a tenant. 

Rules for Investing in Real Estate with a Self-Directed SEP IRA

SEP IRAs often represent an easier path toward retirement savings, but several IRS rules and regulations still govern the account. The most important rules center on disqualified persons and prohibited transactions, how you manage asset-related earnings and expenses, and how you can pay for SEP IRA real estate transactions.

Prohibited transactions and disqualified persons

A prohibited transaction is any improper use of your IRA account. These types of transactions primarily center on self-dealing and disqualified persons.

Self-dealing refers to any transaction in which the account holder or a disqualified person benefits.  Using your IRA to purchase a property you already own is considered self-dealing, as is using your own construction company to renovate a property held in your IRA. 

The concept of self-dealing isn’t limited to account owners, however.  The IRS lists several individuals, besides the account holder, who are considered “disqualified persons.” 

Disqualified persons include the account holder’s spouse, children, parents, and grandparents (and their spouses). The term also applies to others who would directly benefit from the account, such as the account fiduciary and, for SEPs, anyone with 50% or more ownership in the business, officers, directors, and shareholders with 10% or more interest.

Disqualified persons cannot use or benefit from the property. If they do, the engagement is considered a prohibited transaction.  For instance, if you use your SEP IRA to invest in a commercial property, your account fiduciary couldn’t set up office space. Likewise, your family members couldn’t spend the week in a vacation property held by the IRA. 

Managing earnings and expenses

Another key rule to be aware of is how money can flow to and from the rental property.  Any earnings from the property, such as rent or gains from a sale, must go directly back into the account.  

Any fees, bills, or debt associated with the property, such as property management fees or renovation costs, must be paid from the IRA account. 

Financing purchases

If you want to purchase property with your IRA but the account doesn’t have enough to cover the costs, you cannot combine your IRA funds with personal funds (or those from another individual) to complete the purchase. You can roll over funds from another retirement account or partner with another self-directed IRA investor. 

If those aren’t options, you can access funding through a non-recourse loan. Non-recourse loans are secured by the property for which they are used. If you don’t meet your repayment obligations, the lender can take the property but not your personal assets. 

When you use a non-recourse loan for income-earning property, the earnings will be considered unrelated taxable business income (UTBI), and you’ll be required to pay unrelated business income tax (UBIT) each year you carry a loan balance. 

How to Get Started

Starting a SEP IRA is a straightforward process.  These steps can help you get started. 

1. Choose a SEP IRA custodian

Standard SEP IRAs can usually be set up with a bank or brokerage company, but if your goal is to invest in real estate, you’ll need to choose a custodian. Custodians are approved by the IRS to hold and manage self-directed IRA accounts.  While they don’t provide investing advice or control how you invest your funds, they ensure that your account complies with IRS requirements, manage record keeping and tax filing requirements, and process transactions. 

2. Complete the paperwork required to form your SEP IRA

To start a SEP IRA, you must adopt a written agreement that details the plans. You can do this using IRS Form 5305-SEP or a similar document provided by your custodian. 

3. Inform Employees and set up their IRAs.

If you have employees, you must tell them about the SEP IRA and provide them with relevant plan information, such as eligibility requirements and contribution plans.  You will also need to set up an account for each eligible employee. 

4. Make Contributions

As of 2024, you can contribute up to the lesser of 25% of an employee’s compensation or $69,000. If you’re self-employed, you can use an IRS-provided calculator to determine your allowed contribution. 

 Employees are not permitted to contribute to their accounts. 

5. Manage and Monitor the SEP IRA

Once the account is set up, you should manage and monitor it regularly.  This includes keeping records of your contributions, ensuring that those contributions stay within IRS limits and reviewing your annual contributions to ensure they meet your long-term goals and any business budgetary limitations. 

Purchasing real estate with a SEP IRA can be an easier way to save for retirement and avoid unnecessary tax obligations. For more information, contact a concierge team member at Horizon Trust to learn how SEP IRAs work and how to open one. 

FAQs

Are there any restrictions on the types of real estate I can invest in with a SEP IRA? 

No, there are no restrictions on the type of real estate you can invest in. However, there are restrictions on how you use that property. For instance, you can’t purchase it from or allow it to be used by a disqualified person. 

What are the tax advantages of using a SEP IRA to invest in real estate?

When you invest in real estate with a SEP IRA, the earnings from your investment can grow tax-free while in your account. Further, you won’t have to pay capital gains tax on earnings from an IRA-held property. However, if you purchased the property using a non-recourse loan, you’ll likely need to pay unrelated business income tax (UBIT) on earnings. 

How do real estate mutual funds work within a SEP IRA?

Real estate mutual funds are professionally managed securities that an individual can purchase shares of on the open market.  Securities in the funds include REITs and real estate-based companies, making it possible to invest in real estate without purchasing property.  You use your SEP IRA to invest in real estate mutual funds much like you would other common assets, such as stocks, bonds and ordinary mutual funds.