How to Use a Self-Directed IRA to Invest in Real Estate
An individual retirement account (IRA) is a great way to invest for life after retirement. However, when you opt for a regular IRA, it becomes nearly impossible to invest in certain types of assets due to various restrictions. These assets include precious metals, real estate, and cryptocurrencies.
That being said, there’s a way to invest in these ‘forbidden’ assets, and that’s through self-directed IRAs.
As defined on CNBC, a self-directed IRA is a retirement account through which you can invest in a broader range of assets. Compared to a traditional IRA, where you’re limited to only certain asset types, self-directed IRAs leave room for more asset exploration and investment options.
With such flexibility, you can diversify your retirement investments with alternative assets like precious metals or real estate.
How Self-Directed IRA Works
Regular IRAs have custodians, like a bank or a brokerage firm, which limit your investment options to only certain approved securities. However, according to Forbes, self-directed IRAs have specialized custodians that hold the assets within the account. These specialized custodians offer self-directed IRAs where you can own gold bars, real estate, and other assets that are inaccessible in regular IRAs.
Self-Directed IRAs and Investing in Real Estate
Among all the asset options available, most people with self-directed IRAs usually opt to invest in real estate. If you too are interested in using a self-directed IRA to invest in real estate, here are a few helpful pointers.
Search for an Investment
After you’ve opened your self-directed IRA and funded it, you must first look for an investment. As per IRS rules, you’re allowed the direct purchase of a property and acquisition of LLC membership interests. These are common in private equity commercial real estate transactions.
Always remember to work with an established transaction sponsor. The sponsor should ideally have a long and good history of delivering stable and consistent investment returns.
Commit to Your Investment
After you have identified a suitable investment, you must then commit to it. In the case of a direct real estate purchase with a self-directed IRA, you need to place the property under contract.
In an indirect investment scenario, you have to work with the transaction sponsor to complete the required documentation, like the subscription agreement. This is required to formally commit capital toward the investment.
According to RealtyMogul, real estate investments are speculative and involve a lot of risk. Hence, even with the tax advantages self-directed IRAs offer, without a proper investment strategy, you risk losing your retirement savings.
Therefore, if needed, consult financial advisors to assess your investment before you fully commit to it. Otherwise, there’s no backing out from it once you’ve put your retirement funds on the line.
Complete the Due Diligence
For a direct investment, your sale agreement needs to allocate a certain amount of time to complete due diligence on the property. This is done to ensure that the property is as advertised.
The process can include reviewing property surveys as well as environmental reports. It can also include analyzing the property’s financial records.
For an indirect investment, you need to complete the due diligence on the deal sponsor to ensure that they are reputable and experienced. This is to be done in addition to the normal due diligence on the property and market.
Communicate with Your IRA Custodian
As per Investopedia, communicating with a custodian is unique to a self-directed IRA compared to regular IRAs. When the property or sponsor due diligence is done, you must communicate the specifics of the transaction to the custodian of the IRA. These specifics include everything from how much money is needed to where the funds need to be sent.
The rules of such communication remain the same regardless of what type of property you wish to purchase.
Limitations of Self-Directed IRAs
While self-directed individual retirement accounts are good for real estate investments, they do have some downsides. These include the following.
- Apart from real estate, certain assets will always be prohibited from investing in self-directed IRAs. These include artwork, rugs, antiques, stamps, alcohol, etc. Hence, if you want to invest in any of these items, you can’t do so with your self-directed IRA.
- Custodian experiences can greatly vary. You might not always find a suitable custodian to help you navigate the investment process.
- Fees associated with self-directed IRAs can be very expensive.
Final Thoughts
Using self-directed individual retirement account to invest in real estate is a great post-retirement investment option. It comes with numerous benefits, including tax advantages, and also offers lucrative investment options.
Of course, they do come with their own disadvantages. You have to be the one to decide whether or not the pros of self-directed IRAs outweigh their cons. Only then can you make the bold move of opting for a self-directed IRA for real estate investment.
About the Author
Top Wellington Realtor, Michelle Gibson, wrote: “How to Use a Self-Directed IRA to Invest in Real Estate”
Michelle has been specializing in residential real estate since 2001 throughout Wellington Florida and the surrounding area. Whether you’re looking to buy, sell or rent she will guide you through the entire real estate transaction. If you’re ready to put Michelle’s knowledge and expertise to work for you call or e-mail her today.
Areas of service include Wellington, Lake Worth, Royal Palm Beach, Boynton Beach, West Palm Beach, Loxahatchee, Greenacres, and more.
How to Use a Self-Directed IRA to Invest in Real Estate
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