Have You Looked Into Investing In Real Estate With A Self-Directed IRA?
Self-Directed IRAs allow you more choice where you invest your money while still having many protections that a traditional IRA offers. Some of the investment options include real estate, notes, precious metals, tax lien certificates, private placements and many others. Here we will focus on how to use one to invest in real estate.
Grow your Self-directed IRA Nest Eggs Money | Gary Lipsky Real Estate
A Self-Directed IRA can be deemed “traditional”, meaning contributions are tax-deductible in the year you made them, or it can be a “Roth” IRA which doesn’t provide an up-front tax deduction, but you won’t have to pay taxes in retirement at the time of withdrawal. Early withdraw penalties still apply if you need your funds before you reach the age of 59 ½ and count as ordinary income on your tax return. There are benefits to both, and you should strategize with your CPA and/or financial planner to decide which is best for your situation.
Owning real estate in an IRA allows your investment to grow on a tax-deferred basis or in the case of a Roth IRA, tax-free growth. However, if you don’t follow the rules and end up purchasing property the wrong way within an IRA, you could disqualify the IRA which creates a taxable event.
IRA ownership of investment property also loses some of the tax breaks available to real estate owners if the property operates at a loss. Similarly, you will not be able to claim depreciation on IRA-owned real estate.
Self-Directed IRA investment transactions must all be arm’s length transactions which means that no self-dealing, personal transactions or with immediate family members. So, you won’t be able to purchase a vacation home, primary or secondary residence unfortunately.
Some IRAs may have taxable income and need to pay taxes when assets are purchased with debt financing. This potential tax issue is called Unrelated Business Income Tax (UBIT) and occurs when you buy a property within your IRA using the leverage discussed above. For example, let’s say your IRA buys a rental property for $300,000 and that $100,000 came from the IRA and $200,000 came from a non-recourse loan. The property is thus 66% leveraged and as a result, 66% of the income is not a result of the IRAs investment but the result of the debt invested. Because of the debt, the IRS requires tax to be paid on 66% of the income. So, if there is $20K of rental income on the property then $13,200 would be Unrelated Debt-Financed Income (UDFI) and would be subject to UBIT payment. In this case, IRA owners may want to take advantage of the 1031 rules, and exchange their debt-financed property for another. The result of this exchange is that all or most of the IRA income taxes can be deferred.
I came across a real estate syndication deal that had all I looked for in a property but wanted to hold on to my cash for other purposes. Since I had some money in an IRA, I then transferred it into a Self-Directed IRA so I could invest in this exciting new opportunity. That transaction allowed me to learn by seeing how a bigger deal gets done while being able to own my small piece of a 400-bed student housing complex. I have since used this same strategy of a Self-Directed IRA to invest in other properties as well. I haven’t completed a full circle with the investment yet, but I believe strongly that I made the right decision and learned a lot that has been useful for all my future projects.
While investing in real estate with a Self-Directed IRA isn’t for everyone, hopefully, this article gave you a good foundation on which to start your journey to financial freedom. You can also check out my article on my favorite real-estate-investing podcasters where you can hear more about this subject and others about growing your wealth through owning real property.
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