How You Can Invest in Real Estate Using a Self-Directed IRA

What is a Self-Directed IRA?

An Individual Retirement Account (IRA) is a type of savings account that is designed to help you create a healthy nest egg for your retirement while offering multiple tax benefits. However, regular IRAs limit your investments the more traditional assets options such as to mutual funds, stocks and bonds. Whereas a self-directed IRA allows you to go beyond that and broaden your portfolio by investing in other avenues such as real estate, private equity, franchises, etc. instead of letting the financial institution make your investment decisions.

Since self-directed IRAs allow you to diversify your portfolio, a growing number of retirement savers are now choosing to invest in real estate to increase their overall returns. But real estate investments done through self-directed IRAs come with its own set of rules and regulations.

How to Get Started?

In order to invest using a self-directed IRA, the IRA must be held by a qualified trustee or custodian, who can provide administrative services such as maintenance of records, issuing client statements and providing information pertaining to government rules and regulations. Another point to note is that a self-directed IRA also requires you to accurately value your investment annually and report the value to your IRA custodian.

Once you have your IRA set-up all figured out, take a note of the dos and don’ts of using your self-directed IRA to invest in real estate.

  • You can purchase land or property win your IRA as long as it wasn’t previously owned by your or your family members (this includes your spouse, parents and your children). You are also prohibited from selling any property to your spouse, family or any other relative. This rule also extends over leasing of property to family members as they are considered as disqualified persons under the IRA laws.
  • While purchasing a property through your IRA, all property related expenses must be paid using your IRA and thus you must ensure you have sufficient cash in the account. This is because using external capital to fund the management expenses can lead to the loss of tax benefits, or penalties.
  • When renting out your IRA property, tenants must address their rent checks directly to the IRA and not you, personally. This is imperative as accepting rent checks personally could trigger penalties as it is considered to be a prohibited transaction in case of self-directed IRAs.
  • You are not allowed to use any property bought using your IRA as a family/vacation home as all properties owned through your self-directed IRA as designed to bring you benefits only upon retirement and not earlier than that.

Now that you know the rules involved in real estate investments, take a look at the benefits as well as the disadvantages of making such investments through your self-directed IRA:

Benefits of Investing in Real Estate through Your Self-Directed IRA

1. Potential Tax Benefits

While traditional IRAs investments can only prove to be beneficial until the day your take withdrawals or reach your retirement age, real estate IRA investments allow you to buy, sell or flip properties and move funds from one project to another while maintaining the tax deferral status of the IRA.

2. Familiarity

In a world of mutual funds, bonds and stocks, where the markets keep changing uncertainly, real estate is a relatively stable sector that allows you to pick any property of your preference after due diligence.

Downsides of Investing in Real Estate using Your Self-Directed IRA

1. Lack of Portfolio Diversification

One of the biggest downside of investing in real-estate is the lack of portfolio diversification. This is because real estate investments require large sums of cash, which can take up most of your savings, leaving little space for any other type of investment.

2. Lack of Liquidity

Since returns on real estate investments are calculated on the basis of land appreciation over the years, you may not have cash in hand even though your investment has doubled or tripled as it will be considered as an asset.

So, if you are planning to make a real-estate investment using your self-directed IRA, be sure to hire an experienced IRA custodian who can guide you through the investment process and has a good grasp over the rules and regulations. They should be able to guide you and tell you which property is best after gauging your savings and help you diversify your portfolio, so that you can enjoy your retirement years!

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