There has been an increase in the number of savers nearing their retirement, who have become aware that traditional methods of investing their individual retirement accounts (IRA) are not the only way to see a return on investment.

Besides the usual offerings like mutual funds, stocks & bonds, exchange traded funds (ETF), and certificates of deposit, it is possible to self-direct your IRA (SD-IRA) into alternate investments such as real estate.

What is a Self-Directed IRA?

Self-directed IRAs have gained popularity in the last few years as a non-traditional form of investment. They are more accessible for an interested investor who has the ability to research more financial information than previously.

An SD-IRA can be either traditional or Roth (money on which taxes have already been paid) funded. A custodian, a company in physical possession of the investor’s assets, can allow several types of permissible investments in the IRA. Property is one of the alternative options that appeal to a wide range of people.

There are many restrictions attached to this form of investment by the IRS, however.

The term SD-IRA means that the IRA custodian accepts or offers alternative investments. Any IRA custodian refers to the financial institution that is responsible for the record keeping and reporting requirements that the IRS demands. The “SELF-directed” part of the description refers to the annual accurate evaluations you must report to your custodian without fail.

How Property Can Be Purchased Using a Self-Directed IRA

First set up an SD-IRA. This can be done using one of the many reputable companies that provide the individual investor with the service. This is an extremely complex procedure and trained professionals are best equipped to explain the regulations thoroughly to ensure that all the criteria are met.

Your custodian is a necessary guide to the convoluted and perplexing wording of the Inland Revenue Service tax code. They have studied the ins and out of the code extensively and can translate it into language easy for the average person to understand.

Always make good comparisons between all the custodians you are viewing, as some can have a more complicated fee structure than others. Do some in-depth research to examine the expenses and fees the custodian charges, as these can impact your overall ROI (Return on Investment).

It may be advisable to establish an LLC (Limited Liability Company) to hold your investment assets. Other entities are able to hold your investment assets, it is worth asking your custodian for their suggestions on this.

Any SD-IRA must generate enough cash flow for the repairs and maintenance of the investment. Adding cash to pay for these costs is not permitted.

The Benefits of Using IRA Investment funds to Invest in Property

The biggest benefit of buying property with a Self-Directed IRA is the tax advantage. With any IRA investment you will benefit from the tax deferment on your income up until the time you take withdrawals.

The other tax advantage is if the investment holdings are in the form of a Roth IRA (tax has already been paid on the monies used). In both these cases, the investment gains are allowed to accumulate completely tax free and the investor is permitted to withdraw the money without it being eligible for further taxation.

It is still necessary to wait until the age of 59.5 before your funds can be accessed, or else you will be subject to a penalty for the early withdrawal. The money that is withdrawn before the age of 59.5 will be classed as ordinary income when that tax year comes around.

This restriction does not impede the active investor from be able to flip a property and buy or sell others. Funds may still be moved from one property project to another and the tax deferral status will still be maintained by the IRA.

The top of the benefits of investing in property in an IRA is the hands-on familiarity with the procedures. An investor can often feel anxious when money is linked to such markets as the stock exchange and mutual funds, areas where they may not feel as clued in as they would like.

Global markets can often behave in an unpredictable fashion and can seem very opaque to the average person. This is what makes the transparency of investing in real estate all the more desirable. SD-IRAs give you the ability to choose the property investments that you can understand. The real estate that you select can also be made locally which is ideal for anyone who wants to truly keep an eye on their investments.

How to Follow the Rules & Remain Tax-Free

Investing your traditional or Roth IRA in property allows it to grow on a basis that is tax deferred. Not following the rules can challenge your investment’s tax deferral status. Purchasing a property incorrectly within an IRA will disqualify it and it then becomes taxable.

One of these infringements is if the real estate operates at a loss. A property bought for investment within IRA cannot depreciate in value or some of the tax breaks may be lost.

All of the property transactions must be completely tangibly remote to the investor. No personal or family dealings are allowed.

Watch out for UBITs. Unrelated Business Income Tax can become an issue if you are contemplating taking out a mortgage to fund your investment property in full or in part.

As all good things must come to an end, so it is true with traditional IRAs. When turning 70.5 years, an investor must take the required minimum distributions. Owning property within an IRA makes it difficult to sell your property holdings in incremental amounts. For this reason, the investor must have sufficient cash in their IRA accounts in order to cover the required distributions and avoid any subsequent tax problems.

There are so many advantages to using your investment funds to invest in property; make sure to use a knowledgeable custodian who knows the rules and watch your IRA investment grow.

References:

https://www.thebalance.com/how-to-invest-in-real-estate-with-a-self-directed-ira-4057066

https://www.thebalance.com/mutual-funds-beginners-guide-357958

https://www.thebalance.com/investing-for-beginners-4074004

https://twocents.lifehacker.com/how-to-build-an-easy-beginner-set-and-forget-investm-1686878594