Most of us assume that either using cash or a mortgage are the only ways to invest in real estate. Well, it’s time to think outside the box and look at the Self-Directed Individual Retirement Account (SDIRA). What’s that, you ask? A SDIRA allows you more opportunities to diversify beyond traditional stocks, bonds and mutual funds to private market funds, REAL ESTATE and more. It requires you to hire a custodian or trustee of the account while you direct the investments.
How to Get Started
If you are seeking a SDIRA, you will need to look beyond the typical brokerage firm. As an investor, you must look for a company that specializes in SDIRAs due to their broader and more complex diversifications. You can also transfer funds tax-free from your traditional IRA to a SDIRA.
Tips for Investing in Real Estate
- You and your IRA are two separate entities. This is very important as your investment needs to be in the name of the IRA, not you. Usually it would be titled “SDIRA Custodian Company” custodian FBO (for benefit of) “Your Name IRA”.
- One of the more common “tricks” for this is to set up a Limited Liability Company (LLC) with yourself as the manager, Then, your SDIRA can invest in the LLC, giving you more control over when/how to spend money on something. Consult your financial advisor for more information.
- All payments or profits related to your IRA’s investment must be made from your account or return to your account. As well, all expenses must be paid from your IRA account.
- If you don’t have enough cash in your IRA to cover the entire purchase, your IRA can take out a Non-Recourse Loan. A NRL allows the bank to only recoup the property, not the assets of the IRA. The payments will be taken from your IRA cash balance to repay the loan. Two caveats to be aware of: a large down payment is often required and if a rental income is being generated, it could be subject to Unrelated Business Taxable Income (UBTI). Again, every situation is different so please consult your financial advisor.
- Since the IRA is investing in real estate, the property can not be used for any personal reasons.
- You cannot use your IRA to purchase a property that you or a disqualified person owns (your parents, sibling, children, spouse or in-laws). Also, you can’t partner with a disqualified person to purchase a property.
- You cannot benefit at all from your IRA before you retire, nor can your IRA benefit from you.
- Any profits that your investment property makes will go directly back into the IRA. Conversely, all expenses must be paid for by the IRA. This includes the predictable and unpredictable expenses that come with home ownership. You also can not put any “sweat equity” into your property, as this is seen as a payment.
Why Invest in Real Estate with Your IRA
The main reason is taxes! Profits made by an IRA are tax-deferred (or in the case of a Roth IRA, you pay taxes on funds put in but no taken out). This means that any profits you are making would be sitting in the account until you retire and gaining more interest that what you would likely pay in taxes at the time. The catch would be gain taxes. Capital gain taxes are paid when real estate is purchased and max out around 20%. When real estate is purchased as an IRA, it is subject to income taxes which max out around 40%. This would be need to be taken into consideration.
The other advantage is diversification. The real estate market can provide some stability to a portfolio containing only stocks and bonds.
If you are interested in setting up an SDIRA to invest with us, please email firstname.lastname@example.org. Pete has helped others setup and utilize this structure.
Disclaimer: This is meant to be an informative post. It should in no way should be construed as investing advice. ALWAYS check with your attorney and tax professional FIRST.