How To Invest In Real Estate With A Self Directed IRA

What Is a Self-Directed IRA?

An SDIRA is a retirement account that allows you to invest in more than just stocks and bonds, which includes real estate.

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What is the Difference Between a Self-Directed IRA and a Self-Managed IRA?

There are two types of SDIRAs: one that’s custodian controlled and one that’s self-managed (or checkbook controlled). A custodian account entails the account holder directing a custodian to make investments. A self-managed account entails setting up a limited liability company (LLC) and then managing that LLC directly, which allows the holder to control the investments themselves.

How Can a Self-Directed IRA Be Used to Buy Real Estate?

There are plenty of companies that will provide you with the opportunity to get a SDIRA. SDIRA are complicated, so having professional run it on your behalf may be of great benefit. It’s important to shop around, however, because not every company charges the same fees. If you go the self-managed route, then you really have to know what you’re doing.

What Rules Govern A SDIRA?

An SDIRA cannot be used to purchase life insurance, collectibles, or for the purpose of self-dealing. This means if you own a property you can’t live in the finished basement or sell the property to a friend. Your IRA investments must be uniquely titled. You can use your SDIRA to buy real estate using funds other than those in your IRA. If the investment has any expenses, like repairs, then they must be paid using funds in the IRA.

What are the Benefits of Owning Investment Real Estate in an IRA?

An SDIRA gives you greater control of your financial future. If that control is used to establish a diverse investment portfolio then you will be a more resilient investor and a potentially more successful investor (if there’s a greater return on investment). Real estate in particular is a good investment because it’s a material possession that generates regular income. Real estate is also the sort of investment that can go up in value in and of itself.

If the income you make using your SDIRA is tax deffered, then you’ll have to pay taxes upon withdrawl. That’s why many people choose a self-directed Roth IRA, which entails paying taxes before putting your income into your IRA. The benefit occurs if you make more money later in your life than earlier in your life.

What Are the Biggest Downside Risks to Self-Directed IRAs?

If you invest in real estate using your SDIRA than knowing how to invest is on you. For this reason, being knowledgeable is very important and so is having the time and wealth to accumulate and apply that knowledge. Additionally, the cost of real-estate is such that it’s cost prohibitive for most investors to have a diverse real estate portfolio. Lastly, real estate has low liquidity because transforming your investment into accessible funds takes time and may entail a negative return.

What are the Tax Implications?

If you invest in real estate with your Self-Directed IRA then you’ll be able to reap the benefits of tax-difference. But if you don’t follow the rules properly then you can end up boxed out of receiving tax-difference and get taxed. For this reason, yet again, it’s advantageous to have a custodian for your account. One way for your IRA to become a taxable event is if you sell your property to a friend or family member, so don’t do that!

Unfortunately, the particularities of an IRA are such that investors miss out on some of the tax breaks afforded to regular real estate investors if the property generates a negative return. If you use a mortgage to pay for your investment than Unrelated business income tax (UBIT) may become a consideration, which just means more taxes to potentially pay. Lastly, by age 70 ½ you have to start taking minimum distributions out of your IRA. But
unlike a regular IRA, it’s difficult to sell off real-estate piecemeal to get those minimum distributions, so you need to have enough cash to cover taxes and fees.

Any income made by your property is subject to UBTI regardless of whether the property is owned outright or mortgaged. If you manage to pay the mortgage off in 12 months or less, however, you won’t have to pay UDFI. Not everything is subject to UBTI. Exceptions include: dividends, interest, annuities, royalties, most types of rentals, gains, and losses. Any income made from collecting rent on a mortgaged property, however, is subjected to UBTI.

What Strategies Can be used to Purchase Real Estate with a SDIRA?

If you have a self-managed SDIRA, then you can purchase the real estate asset in its entirety. All of the gains must then return to your LLC’s bank account. If you’re going the self-managed route and your LLC lacks the funds to make an investment, you can partner with a family-member, friend, or colleague to make the purchase. Lastly, you can take out a loan to pay for your investment, but it must be a non-recourse loan. That’s a loan that only uses the property as collateral. That way if you default on the loan the lender will collect on the property but not your IRA.

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What are the Key Takeaways?

An SDIRA is a complicated way to save for retirement that comes with risk on account of having to do so much research to manage the account. If, however, you have the time and capacity to do such research, as well as the funds to implement it, you will be granted a greater degree of control over your retirement. This added control will come with added security because a diverse investment portfolio makes you more resilient in the face of economic and market hardship and more likely to enjoy a greater return on investment.

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