Invest in Real Estate with IRA? Have you ever even thought of moving your retirement funds into a self-directed retirement fund so that you can take advantage of IRS-approved investments opportunities within the real estate investing space? Many people do not know that this is possible. And if they do, this may seem like a complicated subject to them, but it really isn’t. Getting started can be very easy. Don’t be intimidated.
With a self-directed fund like a self-directed individual retirement account (SDIRA) or Solo 401(k), you are not limited to investing in stocks, bonds and mutual funds. You can invest in virtually any alternative asset classes you want with the exception of art, collectables, cars, life insurance and S corporations.
The bad news: If your 401(k) is with your current employer, you likely will not be able to do what is called an in-service rollover, as employer plans do not allow for this. You would need to wait until you no longer work for this employer.
Invest in Real Estate with IRA – Why Would You Do This?
The short answer in a word: Diversification. If you are like me, you expect a high degree of control over your financial future, since you’re educating yourself and making the decisions on your investments. Your entire retirement account might be made up of stock or mutual funds. While investing in several of these is itself a form of diversification, it ignores the many other types of investments available to you. As I have said before, you never want to put all your eggs into one basket.
Deploying capital into investments that are not pegged to the stock market is an outstanding hedge against market volatility. Investing outside the stock market can have a stabilizing effect on your portfolio because of this.
A SDIRA gives you the ability to build a very diversified, more robust portfolio, and benefit from alternative assets such as commercial real estate, precious metals, private equity, and even race horses. A SDIRA can give you more flexibility in the risks you are willing to take, and a potentially offer higher rates of return. It can also help hedge against market fluctuations and volatility.
Invest in Real Estate with IRA – Finding a Custodian
Before you transfer any funds to a new retirement fund, you need to find a custodian that allows for checkbook control. By using this type of plan, you avoid the delays that some custodians impose while approving your request for making an investment.
There is a wide array of service providers out there. Some are full-service advisors while others have sort of a self-serve model. You will pay more on the full-service side with yearly charges around $1,500. On the other end, services like Rocket Dollar are very streamlined and will charge $130-$180 annually. Opening up an account will also carry a set up fee. Expect to pay anywhere from $300 or more.
Invest in Real Estate with IRA – Moving Your Money
Before initiating this process, you will need to convert your retirement funds into cash. This makes it a lot easier to get started. When you set up your account with a custodian that allows for checkbook control, this service provider will establish an LLC and use your money to fund that LLC. You will then be made manager of that LLC and be responsible for directing any funds into the investment of your choice, and can do so at a moment’s notice if needed. You alone have the fiduciary rights and responsibilities.
From start to finish, expect the process to take anywhere from 1 to 3 weeks.
Invest in Real Estate with IRA – Types of Accounts and Taxes
There are basically 2 different types of retirement accounts that can be used for investing in real estate: a SDIRA, and a Solo 401(k). With a SDIRA, you will be responsible from certain taxes, especially when investing passively in real estate, but a Solo 401(k) will be exempt from any type of taxes. The reason the SDIRA is subject to taxes when used for a passive multi-family investment has to do with leverage (debt). Since debt, like a mortgage, is bringing in money beyond your retirement dollars from outside your retirement account in order to make it possible, any income on that debt is taxable.
For example: You invest in a $500,000 project. If your investment is $100,000 and there is a mortgage of $400,000, you are responsible for taxes on anything attributed to that $400,000. In this case 80% represents the debt. If in the first year the project earns $50,000, you will be taxed on 80% of that, or $40,000. The remaining $10,000 profit is tax free. The nice thing about investing in real estate is that the $40,000 income can be shielded by depreciation. In most cases this can be almost completely shielded for the first few years of the investment.
Fun fact: The tax above is known as UBIT (unrelated business income tax). A good tax professional, especially one well versed in real estate, should be able to counsel you on the implications of UBIT.
Invest in Real Estate with IRA – Management Issues
As the owner of the self-directed retirement account, you are what is known as a disqualified person. What this means is that anything you invest in with retirement funds cannot benefit you as a person – only the retirement account. Disqualified persons also include linear descendants like your children and grandchildren, linear ascendants like your parents or grandparents, and spouses.
You are also not allowed to manage the day-to-day operations of the investment. You cannot buy and manage a rental property directly, and you cannot rent that property as a tenant. You can’t benefit in any way from the actions of your retirement account. Likewise, your retirement account cannot benefit from any actions on your part.
In other words, the investment has to be a truly passive investment. Investing in a syndication as a limited partner fits this requirement very well, as the syndication’s sponsor manages the rental property without your influence.
Here’s a Tip
If you already have an investment via a SDIRA and a sale is coming up soon, and you happen to have self-employment income, consider transferring that investment from the SDIRA to a Solo 401(k). This will help you eliminate any capital gains taxes.
Helpful Links
How to Invest in Real Estate with IRA
I invest my retirement funds through Rocket Dollar and enjoy their service model and ease of use.
