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Using Self Directed IRA when Investing in Real Estate

Many folks have many reasons for not getting involved in Investing in Real Estate. The number one reason, however is lack of liquidity or available to funds needed to buy property. The truth of the matter is one person doesn’t need to have a huge amount of cash to have success in real estate, it may make things easier but it is not necessary. A great alternative when investing in real estate is to use your Individual Retirement Accounts. Many folks don’t realize they can use their retirement funds when buying real estate, but you can and I highly recommend this funding strategy if you have done your due diligence.

investing in real estateA growing number of retirement savers are becoming aware that they can choose investments other than the traditional offerings of stocks, bonds, mutual funds, ETFs and CDs within an Individual Retirement Account (IRA). Self Directed IRA’s (SD-IRA) offering non-traditional investments have increased in popularity in recent years and are somewhat more accessible for investors compared to 1974 when the IRA was first introduced.These Self-Directed IRAs allow you to invest in real estate, notes, tax lien certificates and many more investment options.

If you wanted to buy a rental property, you would open an IRA custodial account, transfer cash from an existing IRA account — or possibly 401(k) — into the custodial account and then purchase real estate under the IRA account name. Very specific rules outline what you can and cannot do in funding and managing the investment, so make sure to get good advice on those rules.

You can also buy and sell real estate in a self-directed IRA if you are in the flipping business, but there are limits on how many you can do per year. The profits on any transaction would be tax-deferred or tax-free and allow your IRA to continue to grow with those tax advantages.

A Self-Directed IRA is a Traditional or Roth IRA in which the custodian permits a wide range of investments that are allowable in retirement accounts. One of these alternative options, real estate investments, is appealing to many people who consider using a Self-Directed IRA to purchase rental properties.The term “self-directed” means that alternative investments are accepted or offered by the IRA custodian. An IRA custodian is the financial institution responsible for record keeping and IRS reporting requirements.The “self” directed aspect kicks in each year since you must accurately value your investment annually and report the value to your IRA custodian.The first steps when using an IRA is to set up a Self-Directed IRA. Several reputable companies provide individual investors with the ability to set up self-directed retirement accounts.Due to the complex nature of Self-Directed IRAs, it is helpful to have a custodian that will help provide some much-needed guidance as you travel through the murky and confusing waters of the IRS tax code.Some IRA custodians have more complicated fee structures than others.

Therefore, it is important to do your homework and examine all of the potential fees and expenses that will impact the overall return on your investment. In many cases, it is advisable to also establish a limited liability company (LLC) or other entity to hold the investment assets.With Self-Directed IRAs, you must generate sufficient cash flow that will cover all maintenance and repair costs without the need for you to add cash each year.

Perhaps the biggest benefit of using a Self-Directed IRA to purchase real estate is found in the potential tax benefits. As is the case with any investment in your IRA, you benefit from tax-deferred income until the day you take withdrawals, or if your investment holdings are in a Roth IRA, your investment gains get to accumulate tax-free and you are able to withdraw it tax-free. You still must wait until you reach age 59 ½ to withdraw your funds without being subject to an early withdraw penalty and having that included as ordinary income on your tax return.But active investors may buy, sell, or flip properties and move funds from one project to another and still maintain the tax-deferral status of the IRA.Another benefit of owning real estate in an IRA is the familiarity.Investor interest is often sparked by global market uncertainty and this can lead investors to stick with more local investments. Self-Directed IRAs provide you with an ability to invest in investments that you know and understand.

As an account holder in a Self-Directed IRA you are responsible for doing the required due diligence on the property itself. This may be an appealing feature of real estate investing in IRAs if you are a real estate professional or experienced investor. However, it could lead to a bad investment decision or the potential of being a victim of fraud if you are not a savvy real estate investor.The Security and Exchange Commission (SEC) has released an investor alert addressing Self-Directed IRAs and the risk of fraud.One of the biggest risks of owning real estate in a Self-Directed IRA is the potential lack of diversification. While not impossible for super savers who have accumulated substantial amounts of wealth in an IRA, many investors lack the ability to create a diversified real estate investment portfolio. Only focusing on the upside potential is a major risk to consider before purchasing an investment property.

You can’t get a traditional mortgage loan in an IRA, so you really need to have enough money in your IRA to purchase properties for cash if you plan on having the property as a long-term rental. There are also costs to administering the IRA, so factor those into your calculations when penciling out any real estate investment. And you cannot write off losses or depreciation from any investment property in an IRA, so there won’t be the traditional tax savings you’d get on rental properties. Lastly, if you fail to comply with any of the rules, it may kill your IRA and cause you many tax penalties.

Don’t put all of your IRA eggs into one basket. Too many people don’t properly diversify their retirement assets — present company included. It would be smart to talk to a financial adviser on how to allocate all your investment savings into different assets, based on your age and risk tolerance.

If you want to use your IRA to buy real estate, you need to understand what you can and can’t do. As always you also should get professional guidance from an accountant and lawyer. The process of using a self-directed IRA to jump into investing in real estate requires preparation and caution.The move can make sense in certain circumstances, but only when the investor fully understands both the positives and negatives and the requirements involved.

Interested investors should seek legal advice, as well as input from an accountant and real estate agent for a well-rounded picture. They should also be familiar with the rules for the type of IRA they’re using. Whether it is a Simple IRA, Roth or Traditional IRA. Investing in real estate with a self-directed IRA can be very attractive but be aware that it takes time and quite a bit of work but what worthwhile doesn’t. If you do your due diligence, Self Directed IRA’s can be a tremendous avenue and open many doors to investing in real estate.

Happy Investing!

Also, take a look at this article: Buying properties “Subject To”