A self-directed individual retirement account (SDIRA) is a type of IRA, managed by the account owner, that can hold a variety of alternative investments. A self-directed IRA is a type of retirement plan that gives the account holder control over their funds and investment choices. It allows for alternative investments such as real estate and private equity to be used to grow retirement savings.
The account owner has the power to make informed investment decisions and can choose to invest in assets they are knowledgeable about, thereby enhancing their IRA's earning potential.
The account holder of a Self-Directed IRA can invest in a broader range of assets, including real estate. A self-directed IRA is similar to a traditional or Roth IRA in that it allows you to save for retirement tax-free and has the same IRA contribution limits. The only distinction between self-directed and other IRAs is the type of assets held in the account.
What is Self-Directed IRA Real Estate Investing?
Self-Directed IRA Real Estate Investing allows individuals to use their retirement funds held in a Self-Directed Individual Retirement Account (SDIRA) to invest directly in real estate and other non-traditional assets, such as real estate, private placements, and commodities.
This type of IRA gives investors more control and flexibility over their investment choices beyond standard stock and bond options, enabling them to diversify their portfolios by including tangible assets like rental properties or commercial real estate. However, it comes with specific rules and regulations to ensure compliance with IRS guidelines.
Self-directed IRA real estate investing permits individuals to invest in real estate with their retirement funds without paying taxes or penalties on the funds spent or the profits produced. Instead, the investment grows tax-free or tax-deferred until retirement, when it is withdrawn.
Self-directed IRA plans are considered more powerful than traditional IRAs because they offer a wider range of investment options. In addition to traditional stocks, bonds, and mutual funds, self-directed IRAs allow the account holder to invest in alternative assets such as real estate, private equity, and precious metals, providing a potentially broader and more diverse investment portfolio.
The account holder also has more control over their funds and investment decisions, as opposed to having a financial advisor make these choices for them.
Investing in real estate through a Self-Directed IRA can provide a number of advantages, including the possibility of higher returns, diversification of a retirement portfolio, and the ability to invest in a tangible asset with the potential to appreciate in value.
However, it is critical to understand that investing in real estate through a Self-Directed IRA entails risks and responsibilities, such as the need to manage and maintain the property as well as comply with the rules and regulations governing IRAs.
How to Buy Real Estate with Your IRA?
Did you know you can invest your IRA in real estate? Like many people, you might have heard about this before but are not quite sure how it can be done. I’ll walk you through the simple three-step process and how it works. The good news is it’s simple and easy. Let’s walk through each of the three steps one at a time. Following this process allows you to gain control over your retirement account and invest in assets you want to invest in.
STEP 1: You Need a Truly Self-Directed IRA
First, you will need a self-directed IRA (SDIRA). If you were to go down to your bank or brokerage and tell them you need a self-directed IRA they would probably tell you that’s what you have. However, their definition of self-directed means you can choose from a list of limited investment options that they charge a fee or a commission on.
If instead, you ask them if you can take title to a specific property in your IRA, what will they tell you? “You can’t do that” or “you can’t do that here.” Why? Because they can’t charge you a commission on the real estate you purchase so they simply do not permit these types of investments.
What makes an IRA self-directed? The short answer is, it depends entirely on the custodian or trust company that holds your IRA. Each IRA trustee is allowed to impose restrictions on the types of investments they hold. Therefore, you need to choose a truly self-directed IRA custodian, one that allows you to choose your own investments, whatever they might be.
There are several truly self-directed IRA custodians that we work with that are not commission-based institutions like your bank or brokerage. A self-directed IRA custodian will typically charge an annual fee for the IRA service and does not charge commissions or take any percentage of your profits. This affords you the freedom and flexibility to select your own investments.
Most IRA custodians are not self-directed so step one is to identify a truly self-directed IRA custodian and open an SDIRA. Once you’ve identified your new custodian, it only takes a few minutes to open a self-directed IRA account. Most of the process can be handled over the phone or online.
STEP 2: Deposit Money in Your New Self- Directed IRA
Next, you deposit money into your new self-directed IRA. You can do this in a few different ways. First, you can make a contribution. Contributions come from your earned income and you can simply take money from your savings or checking account and deposit it into your new self-directed IRA.
Second, if you have already started a retirement account through a previous employer you can move that money into an SDIRA. You can “roll over” an old 401(k), 403(b), or any other thrift savings plan (TSP) directly into your new self-directed IRA. Third, if you have an IRA already, you can transfer assets or cash from an existing IRA at your bank or brokerage to your new self-directed IRA.
When you do a rollover or transfer properly, there are no taxes, penalties, or fees associated with moving your money from one custodian to another. Now that you have an SDIRA set up and you have money in it, you are ready for the third and final step in the process, to make your first real estate investment.
STEP 3: Make an Investment
This is the final step. You make an investment, in this case, a real estate investment. If this is your first time purchasing real estate in your IRA it is always advisable to contact your custodian first to ask what paperwork you will need to submit. Generally, there is a “Direction to Invest” form that you complete that instructs the custodian on what you are purchasing in your IRA, how much the investment will cost, and where you need to send funds for closing.
One of the most important things to keep in mind is, “Who is going to own the real estate?” Since you are using your SDIRA, it’s not you but your IRA who is purchasing the asset. Therefore, when you write your offer to purchase, the purchaser's name should read as:
XYZ Trust Company FBO Your Name IRA, #12345
Your custodian will sign and process all of the recordable documents since it is the custodian actually making the asset purchasing. Now your SDIRA owns the real estate. When your IRA owns the investment, all the expenses will be paid from your IRA. IRS rules do not permit you to pay expenses personally.
Paying bills for your SDIRA investments is as simple as instructing your custodian to do it. With regards to the income your SDIRA makes, here's the best part of all — all income and profits will return to your IRA, tax protected! No income tax, no capital gains tax — no tax! By investing in a tax-protected environment your wealth can grow exponentially faster than if you are paying taxes as you go.
By following these three simple steps, you will gain control over your retirement account and become an expert SDIRA real estate investor in no time at all.
Pros of Self-Directed IRA Real Estate Investments
Diversification: Real estate investments can provide diversification to an investment portfolio, reducing overall risk.
Potential for High Returns: Real estate can offer higher returns compared to traditional stocks and bonds.
Control: Self-directed IRA account holders have more control over their investments, including the ability to choose properties and make decisions about financing and management.
Tangible Asset: Real estate is a tangible asset that can offer stability and a hedge against inflation.
Cons of Self-Directed IRA Real Estate Investments
Complexity: Real estate investments can be complex and may require a significant amount of research and due diligence.
Risk: Real estate investments carry the risk of property market downturns, declining rental income, and property damage.
High Costs: Real estate investments can be expensive, with costs including property purchase price, financing fees, and property management fees.
Restrictions: There are strict rules and restrictions in place for self-directed IRA investments, including prohibited transactions and disqualified persons. Failure to comply with these rules can result in significant tax penalties.
In summary, Self-Directed IRA real estate investment allows individuals to use their retirement funds to invest in real estate, potentially providing benefits such as higher returns, diversification, and the opportunity to invest in a tangible asset. However, it's important to understand the risks and responsibilities that come with investing in real estate through a Self-Directed IRA.
