“Self Directed IRAs are one of the best laws the US government has ever passed”
Can I invest in real estate with my Self-Directed IRA?
“Self Directed IRAs are one of the best laws the US government has ever passed”, an investor once told me. It is hard to argue that point. In 1974, congress passed the Employee Retirement Income Security Act, often referred to as ERISA, enabling US taxpayers to save money for their retirement in a tax-deferred manner. The best part of this program (outside of the tax deferred nature of it) is that they allow you to self-direct your savings.
ERISA established the individual retirement account (IRA) as a staple in many investors’ toolbox for retirement savings. The IRA allows investors to invest in virtually any investment. While most investors think that they are restricted to stocks, bonds, and mutual funds, the choices are much more interesting. Some ideas that I have seen include: real estate, tax liens, private mortgages, dressage horses, farmland, sports franchises, timberland, physical gold and silver, raw land, private company stock, oil & gas LPs, franchises, and more. With all of these choices, you should have already come up with some ideas that could make for interesting investments.
Real estate and real estate related investments are definitely the most common asset types when it comes to self-directed IRAs. Whether you are a professional investor or a novice, you probably have at least a basic understanding of how real estate works. Here are 10 self-directed IRA tips for investors who want to invest in real estate with the IRA.
- Self-Directed IRAs are tax deferred – The primary reasons investors save with their IRA is to benefit from the tax-deferred nature of the account. If you are 35 years old, you can benefit from the tax-deferred nature until you are 70.5yrs old. While this is when you are required to start taking distributions, you can benefit from the tax-deferred nature of the IRA until all the funds are withdrawn. This gives you 35 years of compounding in which you can benefit from the full amount of the investment without worrying about having taxes reduce your gains. Compounding is a powerful investing principal, you can learn more about how powerful it is here.
- Self-Directed Roth IRAs are tax-free – The Roth IRA was not created with ERISA, it was created much later in 1997 with the Taxpayer Relief Act. This type of IRA allows you to save money and invest in tax-free… forever… well at least during your lifespan. The money you put into the Roth IRA is after-tax money and grows tax-free. This is an enormous benefit for investors who are creative with their investment strategy. Take for example, Peter Thiel who invested in Facebook with his Roth IRA when it was private company. All his gains from that investment are still tax-free, assuming he still has his capital in the Roth IRA. Learn more about $100 million dollar IRAs.
- Investing in rental property – If you have your IRA sitting in mutual funds and you are a professional real estate investor, then you are probably frustrated. Not that mutual funds are bad, but because of this typical real estate investor mindset that I explain here. What you should realize is that you can use your IRA funds to invest in investment property. If you are buying rental property that is netting 8-10% in income each year, why would you invest in areas you are not familiar with? Focus on investing in what you know.
- Physical real estate offers a wide variety of choices – Real estate is a broad category. It includes a number of types that you can choose from. It doesn’t matter what type of real estate it is, residential property, commercial property, industrial property, raw land, timberland, farmland, and more. As long as it is an investment, you can use your IRA funds.
- Real estate related investments are another option – Real estate investors know that real estate is not simple. Experienced investors also know that you can be creative with the terms in order to get the best deal for yourself. Some examples of real estate related investments are, fishing rights, mineral rights, airspace rights, options, private mortgages, tax liens, municipal liens, condo liens, and more. If you find a good investment, consider whether it can be used inside your self-directed IRA to maximize the tax benefits.
- Disqualified persons – There are a number of restrictions that put some limitations on IRA investments. The purpose of these restrictions is to make sure that investors don’t try to circumvent the rules. One of these restrictions is that your IRA cannot do business with a disqualified person. Here is an explanation of disqualified persons. For example, if your IRA owns a rental property, you cannot personally fix the roof. You also cannot rent it out to your mother.
- Prohibited transactions can disqualify your IRA –A prohibited transaction is an action that breaks the rules outlined in the Internal Revenue Code. This prohibited transaction would cause your IRA to be disqualified and would be seen as a distribution of the funds by the IRS. Thus you would have to pay the taxes, interest, and penalties from those funds. My advice, don’t try to circumvent the rules. No matter how smart you think you are, the risk is just not worth the potential rewards. The self-directed IRA is such as gift in the US tax code, there aren’t any good reasons to operate outside the rules. Know the rules and follow them.
- Real estate professionals get an unfair advantage – If you are a real estate professional, Self-Directed IRAs can help you grow your business. With less than 20% of the population knowing about self-directed IRAs, there is a whole world of potential investors that you could help by explaining the benefits of self-directed IRAs and how it can help their investments. Whether you are a real estate agent, attorney, CPA, lender, or insurance agent, if you are trying to grow your business this is a great way to win new clients. If you want to know more about how we can help you, contact us.
- Get creative – There are numerous ways to take advantage of the self-directed IRA. While some investors want to hold their investment property long term, some choose to flip real estate. This can be a good strategy for a more active investor. As long as you know the rules, there are a lot of options as to how investors can benefit from using their IRA to invest in real estate.
- Be the bank – Not everyone wants to invest in physical real estate. Some investors choose to be the bank and provide financing for real estate investors. This is also a common investment strategy for experienced and novice investors alike. Your IRA could loan money to another real estate investor. This would mean you don’t have to do the management of the real estate yourself, just collect your interest. With the rates that private mortgages typically offer, this can be an interesting investment strategy.
How can you learn more about Self-Directed IRA investing in real estate?
While there are many more self-directed IRA tips on how real estate investors can benefit from using their self-directed IRA, we will save the good stuff for later. If you are interested in becoming a client, you will get the full breadth of our knowledge at your disposal. You can contact us here.
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About Innovative Advisory Group: Innovative Advisory Group, LLC (IAG), an independent Registered Investment Advisory Firm, is bringing innovation to the wealth management industry by combining both traditional and alternative investments. IAG is unique in that they have an extensive understanding of the regulatory and financial considerations involved with alternative investments held in self-directed IRAs and other retirement accounts. IAG advises clients on traditional investments, such as stocks, bonds, and mutual funds, as well as advising clients on alternative investments. IAG has a value-oriented approach to investing, which integrates specialized investment experience with extensive resources.
For more information, you can visit innovativewealth.com
About the author: Kirk Chisholm is a Wealth Manager and Principal at Innovative Advisory Group. His roles at IAG are co-chair of the Investment Committee and Head of the Traditional Investment Risk Management Group. His background and areas of focus are portfolio management and investment analysis in both the traditional and alternative investment markets. He received a BA degree in Economics from Trinity College in Hartford, CT.