With a self-directed IRA or SDIRA, you can diversify your investments to include real estate, business, notes, vehicles and just about anything not restricted by the IRA. Essentially, self-directed IRAs allow the investor complete control over investments.
Real estate investments are popular with self-directed IRA investors and there are four ways to do this:
i) Wholesale property – where the contract is in the IRA’s name rather than in the investor’s name. The initial investment or down payment comes from the IRA. After the contract is assigned, the assignment fee returns to the IRA. Where a Roth IRA is involved, the returns are tax-free.
ii) Buy an option in real estate and use it or assign it to a third party or have it canceled for a fee.
iii) Buy property by financing it with the IRA or through a non-recourse loan from a lender. The returns on this debt-financed investment in your IRA can attract Unrelated Business Income Tax (UBIT).
iv) You can partner 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 real estate construction. For example, Jack uses $25,000 from his self-directed IRA to buy an old foreclosed property. He spends $25,000 to $35,000 again from the retirement account towards repairs and renovation of the property. After this, he rents it out for around $1000 a month, which will go into his IRA. This rental 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. Supposing Jack keeps the property for around six to eight years, the price is likely to have 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 is holding 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 Investment Facts
There are plenty of properties on the market and the self-directed IRA is an immediate source of funds to invest in them. Even though the investor can invest in raw land, commercial or residential rental properties, he cannot live in the property. In addition, real estate is a great investment for tax purposes, as expenses are deductible. However, selling the property attracts long-term capital gains at 15%. If this investment is within an IRA, the expenses are not deductible. When sold, the profit on the transaction is also taxed when withdrawn from the IRA as ordinary income. On the other hand, if the real estate investment is within a Roth IRA, the distributions come tax-free provided 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 the IRS guidelines to avoid the risk of having the account disqualified and incurring severe tax penalties. These rules do not allow the investor or relatives to occupy the property. All expenses including repairs, property taxes, etc. will be funded from the IRA. The investor has to ensure that there are enough funds available.
The solution, then, is to choose properties in locations where there is good rent 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 said, SDIRAs are still a lucrative investment tool for real estate properties.
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Source by Corwin Smith
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