Self-Directed IRA and Real Estate
(DISCLAIMER: The materials presented here aim to provide general information regarding the above subject. Nothing here is intended to provide any legal, tax, or financial advice to its readers. Consult with your attorney, CPA, and/or financial advisor regarding your specific situation.)
Retirement Accounts
A retirement account is a long-term investment account with tax advantages that allows individuals to save and invest with the primary purpose of having funds once they retire from working. Typically, people will take money out of their retirement accounts when they are older or have reached a milestone age, such as 55. Depending on what type of retirement account, there are varying limits on how much can be contributed each year and they may have penalties if you withdraw funds before you reach a certain age.
The funds in your retirement account are typically invested in securities that allow it to grow over time. This means that the value of your retirement account will go up and down based on the performance of your investments, but over long periods of time, any gains you’ve made should outweigh any losses (historically speaking).
The most common retirement accounts are Individual Retirement Account (IRA) and 401K.
Individual Retirement Accounts (IRA)
In 1974, the Employee Retirement Income Security Act was passed by Congress. This provided U.S. taxpayers with the opportunity to invest a portion of their earnings for retirement and reduce their taxable income by the amount of their contributions. This opened the door to what we today call Individual Retirement Accounts or IRAs.
These funds grow tax-free until you withdraw them, at which point they become taxable income. However, you must take your first Required Minimum Distribution (RMD) for the year in which you turn age 72 (70 1/2 if you reach 70 1/2 before January 1, 2020). These withdrawals count as taxable income.
401 (k) Plan
In January 1980, the Revenue Act of 1978 gave employees a tax-free way to defer compensation from bonuses and stock options under section 401(k) of the Internal Revenue Code. In 1981, the IRS issued additional rules that allowed employees to contribute to their 401(k) plans through salary deductions. That is, instead of taking a portion of their salary in cash, the employee chooses to have that portion contributed to their 401k account on their behalf by their employer. However, there is a limit to the amount an employee can contribute which is $20,500 for this year 2022.
How to Invest in Real Estate with a Self-Directed IRA?
There are a few different ways to grow the funds in your Self-Directed Individual Retirement Account (SDIRA). You can invest in stocks, bonds, mutual funds, or exchange-traded securities. Alternatively, you can use the money in your SDIRA to purchase real estate as an investment property.
Consult Your Financial Advisor
Understand the Risks
Familiarize Yourself with the Rules
Make Educated Decisions
Invest
Consult Your Financial Advisor
If you’re interested in investing in real estate with a self-directed IRA, the very first step that you should do is to consult with your financial advisor. Your advisor will be able to tell you about the pros and cons of this type of investment, advise if you should set up an LLC, a trust, or an account with a custodian, and determine if investing in real estate meets the goal of growing funds for your retirement.
Understand the Risks
Determining risk tolerance is important before investing in real estate. Before you even consider making an investment, you should take some time to think about your attitude toward risk. Investments are never without risk, and that’s true of real estate investments as well. There are inherent risks associated with every investment; the key to being a successful investor is understanding your risk tolerance and knowing what type of returns you need in order to achieve your financial goals.
As you evaluate your risk tolerance, ask yourself these questions:
How much can I afford to lose?
Will I sleep at night if my investment loses value?
Is my investment diversified enough?
Familiarize Yourself with the Rules
The next step that you should take before investing is to understand and familiarize yourself with the rules of investing in real estate with a Self-Directed IRA. The IRS has clear guidelines when it comes to purchasing real estate using a Self-Directed IRA, so it’s important that you know what these guidelines are.
The IRS is concerned about people using their retirement accounts to invest in assets for themselves instead of for their retirement. To make sure that investors stay in line, the IRS has set up certain rules for purchasing real estate with a Self-Directed IRA. One of the most important rules to keep in mind is called Prohibited Transactions. A Prohibited Transaction happens when a disqualified person engages in a transaction with an IRA or its assets or receives an improper benefit from an IRA or its assets.
A disqualified person is someone who falls into one of the following groups:
- An IRA owner;
- A fiduciary;
- A family member of the IRA owner;
- A business partner of the IRA owner; and
- An entity owned 50% or more by any of the above parties
Make Educated Decisions
After carefully assessing your risk tolerance and determining that investing in real estate with a Self-Directed IRA meets your investment goals, make sure that you know the real estate project that you’re investing in. You have to do due diligence and research well so you can make an educated decision.
Know if the property will be used as a rental property or if it’s going to be sold immediately after purchase.
Consider the location of the property. Do you want it near so that maintenance and tenant relations would be easier? You also want to find out if the property is close to schools, transportation, shopping centers, etc., as these may affect the value of the property in the future.
Check out its physical structure to see if there are any problems that should be addressed immediately. Know what repairs are needed and how much they would cost.
Invest
There are several ways to invest in real estate with a Self-Directed IRA. One of those is through real estate crowdfunding platforms such as EquityDoor.
EquityDoor is a real estate crowdfunding platform that allows investors to participate in various real estate projects across the country. These projects include multifamily, retail, and office properties.
Investors are able to invest through their Self-Directed IRA by working with a custodian or administrator. Once an account is set up, the investor may make their investment through the EquityDoor website.
Investments are available for as low as $1000. Each project has a specific time frame for investment that can be found on the website. Also, EquityDoor does not charge any additional fees for investing from your Self-Directed IRA.
To learn more about real estate crowdfunding you may call us at (512) 335-9400 or use this calendar to book a meeting.
IRA and 401K Basics
In 1974 Congress enacted the Employee Retirement Income Security Act which allowed taxpayers the opportunity to invest a portion of their earnings for retirement and reduce their taxable income by the amount of their contributions. This opened the door to what we today call Individual Retirement Accounts or IRAs.
In January 1980 the Revenue Act of 1978 gave employees a tax-free way to defer compensation from bonuses and stock options under section 401(k). In 1981, the IRS issued additional rules that allowed employees to contribute to their 401(k) plans through salary deductions, which jump-started the widespread roll-out of 401K plans as we now know them.
Since that time, investors have been leveraging both IRAs and 401K plans to save for retirement while simultaneously easing their tax annual tax burden (up to allowable amount).
Use A Self-Directed IRA Or Covert A Retirement Plan For Real Estate Investing
Traditional IRAs and retirement plans have been limited to investing in stocks, bonds, mutual funds, ETFs, etc. Some investors have searched for opportunities to diversify their investments beyond the market, giving rise to Self-Directed IRAs (SDIRAs). SDIRAs open up a large universe of potential investments, including real estate investing.
401K plans, as employee-sponsored programs, are limited in scope and don’t allow investing in real estate. However, employees can convert (or roll over) their 401K investments from a former employer into an IRA which can be structured as a Self-Directed IRA with the assistance of special firms that offer SDIRA custody services.
SDIRA Limitations
Of course, there are limitations on SDIRAs as well. For example, you can’t hold life insurance, S Corporation stocks, any investment that constitutes a prohibited transaction (such as one that involves “self-dealing”) or collectibles.