An IRA is any kind of individual retirement account that you can use if you want to contribute some of your pre-taxed income to various investments that are tax-deferred, which means that you can delay paying taxes on these investments until a future date. A notable benefit of investing your money in an IRA is that the IRS doesn’t assess dividend income or capital gains taxes until you withdraw funds. The contributions that you make to a standard IRA can be tax deductible depending on your tax-filing status, income level, and other factors.
If you want to invest some of your money into real estate through an IRA, you should investigate a self-directed IRA. This is a type of IRA is very similar to a traditional IRA with the main difference being that self-directed IRAs allow individuals to contribute to several different types of investments that aren’t allowed with standard IRAs. These alternative investments include:
- Tax lien certificates
- Precious metals
- Limited partnerships
- Private placements
- Real estate
The IRA account that you create is held by a third party, such as a trustee or custodian. However, you will still be able to directly manage the account. If you’ve been thinking about making investments in real estate, you could use a self-directed IRA to do so.
The Main Benefits of Using Your IRA to Invest in Real Estate
There are many benefits that come with using your IRA to invest in real estate aside from the obvious tax break advantages. Real estate investments are notable for typically providing investors with stable returns over a lengthy period of time. If you would like to balance your investment portfolio, these investments allow for a relatively safe approach to investing that can pair well with some riskier investments. Real estate typically has a very low correlation with other types of asset classes, which means that adding real estate to your portfolio can help you decrease portfolio volatility while providing a higher return for each unit of risk.
There are a few examples of benefits that are specific to using an IRA to invest in real estate. For one, real estate will typically appreciate over time and has historically done so, which is good for your IRA account since an IRA is a long-term investment. Real estate investing is also able to offset the overall volatility of your portfolio, which can be beneficial for you if your portfolio is otherwise filled with risky investments. You may want a relatively stable investment in your portfolio that can provide you with steady returns while you wait to see if your riskier investments pan out.
Real estate investments can also provide you with a consistent income stream that’s taken from renting the building out to tenants or investing in trust deed backed notes. Any of the income that you collect will be able to grow tax-free in your IRA. It’s also important to understand that returns generated from alternative investments are able to be contributed to your IRA and can grow tax-free.
Important Things to Keep in Mind
Before you get started with real estate investing, keep in mind that the real estate property can only be used by you for investment purposes, which means that you’ll be unable to use the property as a place for your children to live, as a vacation home, as an office that’s used for your business, or as a second home. You won’t be able to directly benefit from your investment other than using the returns from the investments to contribute to the IRA that you’ve set up.
Any of the income that you collect also goes back to your IRA, which may not always be ideal. There are numerous people in your life who won’t be able to benefit from the purchase that you’ve made, which means that certain people will be unable to live in the property that you purchase or sell you the property. The people who are disqualified from benefiting from your investment include all of your family members, which extends to spouses, children, parents, grandparents, and in-laws. You should also understand that the trustee or custodian who manages your IRA will be unable to benefit as well. The same is true of any entities that own over 50 percent of the property that you’ve invested in.
One concern that you should keep in mind before you invest in real estate with an individual retirement account is that getting a mortgage for your IRA can be very difficult. You will likely be required to use some of the cash that’s currently in your IRA in order to invest in and purchase the property. If you decide to use some of the cash in your IRA to purchase the property, you won’t be able to benefit from the property tax deductions, depreciation, or deductible mortgage interest payments.
While there are a few downsides to investing in real estate with an IRA, one additional benefit is that all of the maintenance and repair costs for the property in question won’t come directly from your pocket. Instead, the funds that you’ve placed in your IRA can be used to cover the costs.
Selling Real Estate Property Purchased With Your IRA
When it comes time to sell the property that you’ve invested in, it’s possible to initiate the sale of the property in the exact same way that you would with property that wasn’t purchased with an IRA. To begin this process, you will need to find some other party who is interested in buying the property, which can take some time depending on the market and the value of the property that you’re selling. Once you’ve found the right buyer, you will be tasked with coming to an agreement on the selling price. On this front, it’s highly recommended that you partner with a real estate agent to make sure that you avoid making any mistakes and that you don’t sell the property for less than you had intended.
After you have come to an agreement, you should immediately contact your trustee or custodian to sell the property on the behalf of the IRA. What happens after the property has been sold depends on the exact type of IRA that you have. While all of the money that you make from the sale of the property will go back into the IRA that you have, this money can either be tax-free or tax-deferred. Selling a property that was purchased with an IRA should be a simple and straightforward process as long as you follow these guidelines.
Do You Want to Get Started Using Your IRA to Invest in Real Estate?
If you want to get started with using your IRA to invest in real estate, there are five basic steps that you should adhere to. First of all, you’ll want to identify a possible investment, after which you should complete the necessary due diligence.
Once you’ve found the right property and have made sure that it provides you with a worthy investment opportunity, you should request funds from your IRA so that you can direct your investment. This requires the completion of a Direction of Investment form for the IRA. When you’ve notified the IRA that you intend to use funds from the account to invest in real estate, the next step involves waiting for the investment to be fully processed, which should be handled by the trustee or custodian of your IRA.
Even though your IRA will essentially own the title for the property that you’ve invested in, you will be able to manage the investment once the purchase has gone through. While any profits that you make from the property must be immediately sent to the IRA, you should be able to obtain a tax deferment on the money. The final step of investing in real estate with an IRA involves the creation of an exit strategy.
The amount of time that you hold the property all depends on your preference. If you feel that the local real estate market may soon start to falter, you could begin to look for a buyer to purchase the property from you. If you put an effective exit strategy in place, you’ll likely be prepared for any situation that arises. With these tips in mind, you should have a good idea about purchasing real estate with an IRA and the benefits that it can provide for you and your investment portfolio.
*Disclaimer: The statements and opinions expressed in this article are solely those of AB Capital. AB Capital makes no representations, warranties or guaranties as to the accuracy or completeness of any information contained in this article. AB Capital is licensed by the Financial Division of the California Department of Business Oversight as a California finance lender and broker (DBO Lic. No. 60DBO-69427). AB Capital makes money from providing bridge loans. Nothing stated in this article should be interpreted, construed or used as legal, financial, investment or tax planning advice, or a substitute for thorough due diligence and the exercise of sound independent judgment. If you are considering obtaining a bridge loan, it is recommended that you consult with persons that you trust including but not limited to real estate brokers, attorneys, accountants or financial advisors.