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With a self-directed IRA or SDIRA, you can diversify your investments to include real estate, businesses, notes, vehicles, and just about anything not restricted by the IRA. Essentially, self-directed IRAs allow the investor full control over the investments.
Real estate investing is popular with self-directed IRA investors and there are four ways to do it:
i) Wholesale ownership: when the contract is in the name of the IRA instead of the name of the investor. The initial investment or initial payment comes from the IRA. After the contract is assigned, the assignment fee goes back to the IRA. When it comes to a Roth IRA, returns are tax-free.
ii) Buy an option on real estate and use it or assign it to a third party or cancel it in exchange for a commission.
iii) Buy a property by financing it with the IRA or by using a non-recourse loan from a lender. The returns on this debt-financed investment in your IRA may attract Unrelated Business Income Tax (UBIT).
iv) You may associate your IRA with another IRA or non-IRA investors.
Self-Directed IRA: A Profitable Long-Term Investment Tool
There are several advantages to using self-directed IRAs to invest in building real estate. For example, Jack uses $25,000 from his self-directed IRA to buy a repossessed old property. He spends $25,000 to $35,000 again from the retirement account for property repairs and renovations. After this, he rents it out for around $1000 a month, which will go into his IRA. This rent money will generate tax-deferred money. So when Jack sells the property, the proceeds from the sale go into the IRA without incurring capital gains tax. Assuming Jack holds onto the property for six to eight years, it is likely that the price has appreciated, which would mean a significant profit for his IRA. If Jack identifies another property that looks like it will appreciate faster than the current one, he can sell the property he owns and use the money to invest in the new property. Therefore, the self-directed IRA is a great investment tool for the long-term investor.
Self-Directed IRA Real Estate Investing Facts
There are many properties on the market and the self-directed IRA is an immediate source of funds to invest in them. Although the investor can invest in raw land, commercial or residential rental properties, he cannot live on the property. In addition, real estate is a great investment for tax purposes, since the expenses are deductible. However, the sale of the property attracts long-term capital gains of 15%. If this investment is in an IRA, the expenses are not deductible. When sold, the gain from the transaction is also taxed when it is withdrawn from the IRA as ordinary income. On the other hand, if the real estate investment is inside a Roth IRA, distributions are tax-free as long as the account has been there for at least five years.
Uncle Sam is watching
Real estate investments through a self-directed IRA must strictly follow IRS guidelines to avoid the risk of having the account disqualified and incurring severe tax penalties. These rules do not allow the investor or relative to occupy the property. All expenses including repairs, property taxes, etc. It will be funded by the IRA. The investor has to make sure that there are enough funds available.
The solution, then, is to choose properties where rents are good and long-term appreciation is high. The IRA investor can make the real estate investment in cash, or opt for a non-recourse loan. They can also partner with themselves where their IRA contributes 50% and they contribute the balance from their personal savings account. That being said, SDIRAs continue to be a lucrative investment tool for real estate.