Buying Rental Property with a Self-Directed IRA
Investing in a self-directed IRA opens the door to many different possibilities beyond the traditional. While bank trusts offer investments in stocks, bonds and mutual funds, opening a SDIRA allows you to invest more options to create diversified, long-term account growth.
One of the most common alternative assets account holders are interested in adding to their portfolio is real estate property. If you are considering purchasing investment property or exploring the option of rental properties here are 10 tips to help you get started.
As always, with any investment, it’s crucial to perform your due diligence and select the right retirement plan for your future. As you venture into real estate investments, consider the following tips.
#1 A Familiar Investment
Real estate is a common investment. Many investors use their directed IRA to purchase investment property because it is an asset that can be handled on a local scale. With uncertain markets, having a physical investment provides added security, especially since it can be utilized in several ways. Additionally, account holders usually have some form of experience with real estate; it’s crucial to have familiarity with an asset if you plan on using it to build your future. Also, with buying real estate and rental properties being such a common investment, it makes selecting an IRA custodian easier.
#2 Select the Right Custodian
As an SDIRA holder, you must have a certified IRA custodian oversee your account as per IRS regulations. If you are interested in purchasing real estate, the custodian you select should have experience handling various investment properties. There are many possible custodians to choose from; it’s best to perform some thorough research to be certain the one you choose isn’t costing you more than you are putting away. The custodian should be well-versed in real estate investment, have reasonable fees, and should be well-reviewed by the Better Business Bureau. Finding the best custodian could save you a lot of trouble in the future.
#3 Choose the Right Account
Much like selecting the best custodian, account holders need to choose the best IRA account for their situation. Traditional IRA accounts allow all contributions to grow tax-deferred. Any funds flowing into your IRA will grow untaxed until you withdraw funds after retirement. This allows for better long-term growth over the life of the fund. Alternatively, Roth IRA contributions are post-tax; this allows the fund to over time with tax-free withdrawals when you reach retirement age. Depending on your starting situation, either account could be beneficial to your long-term account growth. Consider your situation and select the account that best suits your investment style.
#4 Consider Opening an LLC Account
While a self-directed account allows you to have control over your retirement fund, every transaction must go through your IRA custodian. Sometimes in the real estate market timing is crucial. Waiting for a custodian could result in the loss of an investment. If you would like more control over your SDIRA funds, consider opening a limited liability company, or LLC. Doing so will protect your real estate assets, allow you “checkbook control” when you need it, and add additional security to your IRA investments. This tactic is especially helpful if you plan on purchasing a few properties with your IRA. This added security will make it easier to manage your real estate investments for maximum profit.
#5 Purchase Property Properly
With the added freedom of a self-directed account, investors can be over-enthusiastic with asset investment. Any would-be investor needs to take the steps to assure they are following the correct procedures when purchasing assets. Not doing so can cause tax-penalties on your retirement account. If you don’t have the proper funds when buying real estate, you may be tempted to open a mortgage or take out a loan. Property can accrue unrelated business income tax (UBIT) should you decide to use loan money to purchase any property. Real estate investment is an expensive process; be sure you have the proper funds if you want to avoid UBIT.
#6 Investing in Rental Properties
As a real estate investor, you become the landlord. Whether you select residential, commercial, or a different type of property, you are responsible for the care of that land. All income from your investment property is filtered into your SDIRA. Any changes or improvements made to your real estate investment must be handled through your SDIRA account, not your personal funds. It’s also important to note that you cannot personally use any real estate purchased with your IRA or LLC. Additionally, you cannot rent to anyone considered a disqualified person.
#7 Flipping Properties
Active investors can purchase real estate, sell and flip properties for a substantial gain. If you have sufficient funds, buying real estate with intention to flip has potential to grow your investment quickly, depending on the investment and the market. All funds should be handled within the IRA, and the cashflow will grow according to the type of IRA you’ve selected. While this investment style could bring in a lump sum, it can be very costly. Be sure you have enough to finance your real estate investments beforehand.
#8 Be Wary of Fraud
Though real estate investment is more common, that doesn’t make it fool-proof. Be sure to perform your due diligence when selecting your properties. Your investments shouldn’t be money-pits; the goal is to save more money than you spend. There are multiple factors involved in purchasing real estate. If a property fails inspection, requires extensive work, or is in a less than ideal spot, it would be wise to step away.
Be sure that the seller isn’t trying to unload a fixer-upper or property with “lots of possibilities.” Don’t fall victim to poor investments or bite off more than you chew with a house you intend to flip.
#9 Real Estate to Hold on To
Selecting a real estate investment may be a long-term situation. This asset lacks liquidity; if you aren’t in a seller’s market, you may be holding on to your investment property for some time. While this isn’t a bad thing if you intend to use it as a rental property, having too much real estate can make your profile less diverse. Real estate is one of the more expensive assets to invest in; putting all your eggs into this one basket can cause a stunt in account growth.
Additionally, you may not be able to immediately access the value of your investment. When you reach retirement age, real estate is harder to assess.
#10 Avoiding Pitfalls
With any investment, account holders face potential pitfalls. Performing your due diligence can save your account from disqualification, so long as you follow the rules accordingly. Investors must report all property values to their IRA custodian. Not doing so can result in a fraud charge leading to tax penalties or the complete disqualification of the account.
]You may suffer a loss in profit if your property values drop, but you must update your custodian regardless. Additionally, you must keep your distance from your investments to avoid self-dealing. Any real estate property purchased with your IRA should be handled by your IRA and not your personal funds. Separating the two will be more helpful in the long-run. As you reach retirement age, be sure to keep enough funds in your account to cover your required minimum distributions (RMDs) when you reach 70 ½.
Investing in Your Future
As you explore your retirement options, perform your due diligence to be sure that you’ve selected the best assets and account that work for you. Real estate investment can be the perfect way to build a healthy nest egg for your golden years. With any investment, it’s important to seek out financial advice and to research before making any purchases. Consider your options, contact us and start investing today.