A self-directed IRA (SDIRA) offers investors additional investment options when investing for retirement. Traditionally, stocks and mutual funds are the assets investors invest in with their IRAs. A self-directed IRA opens the door to alternative assets such as real estate, private placements, and syndications. In addition to this freedom, investors benefit from the tax advantages.
A self-directed IRA is a legally structured retirement account, similar to a traditional or Roth IRA. The same tax advantages and annual contribution limits apply however; SDIRAs offer individuals the option to invest their retirement funds into assets commonly referred to as alternative investments, such as real estate syndications.
Brokerage firms, insurance companies, and banks have traditionally decided which assets could be held in 401(k)s and IRAs. Their conventional method of investing limited the investor’s options to mutual funds, public stocks, and bonds. A lot has changed since the introduction of the traditional IRA in 1974.
Today, information is much more readily available to the average investor from a number of different credible sources. Investors looking for diversification with their retirement investments are more informed than ever to make logical investment decisions without exclusively relying on the conventional advisor.
What Is The Reason An Investor Would Open A Self-Directed IRA?
When an individual opens and funds a traditional retirement account, they are handing over control to financial advisors and Wall Street. Self-directed retirement accounts take back control and allow the individual to choose which investments best suit them while benefiting from the tax benefits allotted by their retirement account.
Investors are able to research and perform their own due diligence on the sponsors and the properties themselves. Individual investors may realize that real estate not only provides the potential for better returns but also diversification away from traditional investments.
How Does A Self-Directed IRA Work?
Most traditional investment brokerages that service 401(k) accounts and IRAs will not setup a self-directed IRA for you. Investors need to open a SDIRA with a custodian that handles self-directed accounts and then transfer funds from your current IRA account directly to the SDIRA account. There are several self-directed IRA custodians that have worked with individuals to direct their retirement accounts (contact us to be connected to the one we use). It is extremely important to follow the rules when transferring your retirement funds and work with a trustworthy custodian.
The Accounts That Are Able To Be Used Include:
- Defined Benefit Plans or Profit-Sharing Plans
- Traditional or Roth IRA
- SEP or SIMPLE IRA
- 401(k) or any employer’s plan (403b, 457, TSP, etc.)
Why Is Real Estate A Focal Point For Self-Directed IRAs?
Real estate is one of the most popular investments for self-directed IRAs. This tangible asset has proven to be a solid investment vehicle and a multigenerational producer of wealth. Couple the historical performance of real estate with the consistent income it provides, and you have an investment that will produce income in an up, down or sideways market. Instead of considering real estate to be an alternative retirement investment; many investors believe it to be the fundamental instrument for growing an IRA.
What Rules Must Be Followed For Investing Into Real Estate?
It is extremely important to follow all of the rules outlined by the IRS in regard to IRAs. An improper purchase will nullify the IRA and all funds will now be taxable. The most important rules include; no buying or selling to or from a related party, no property improvements are able to be performed by the investor and no personal or family benefits should be derived from the property (you are unable to use the property yourself or rent to a family member).
For example; if you invested $250,000, from your SDIRA, to purchase a rental property, and you allowed a family member to move in, paying rent or not, the investment would be disapproved, trigging full distribution and tax penalties.
The real estate purchased through your self-directed IRA must be for investment purposes only. The investments are handled through your SDIRA custodian and when distributions are executed, the funds (principal and dividends) are sent to your SDIRA via the custodian and they are now available to be reinvested in the next opportunity.
Why Would I Not Want To Invest In Real Estate With A SDIRA?
There are two main arguments against using a self-directed IRA to invest in real estate.
- Real estate provides some tremendous tax advantages, including interest write-offs and depreciation. When an investor utilizes their SDIRA to invest in real estate, they do not benefit from these tax shelters. Traditional investments (stocks, bonds, and mutual funds) do not possess any of these tax efficiencies either; concluding that through a retirement account, the taxes are similar.
- Real estate is an illiquid investment; for this reason, older investors should be cognizant of the Required Minimum Distributions (RMDs) and how these withdrawals will influence their real estate investments. Contact your accountant and visit IRS.gov for more information.
What Is The Next Step?
It is important to understand your current retirement account as well as the self-directed account you are planning to transfer a portion of your funds into. This includes researching the proposed SDIRA custodian and understanding how the whole process works. Remember that a custodian is required for self-directed accounts; they are actually investing the funds into assets you instruct them to. Any returns, dividends or distributions are sent directly to the custodian and back into your self-directed IRA. It is suggested that you speak to an accountant prior to opening a self-directed IRA.
Next, is researching the real estate investment sponsor who will be managing the property on your behalf. Every property opportunity the sponsor has will be different. Make sure that you fully understand the holding period and that the investment is illiquid until it is sold or refinanced.