An SDIRA provides more options for real estate investment than you could ever imagine, and real estate investors are very creative when it comes to taking advantage of tax benefits. The growth of these investments in Individual Retirement Accounts (IRAs) is either tax-free or tax-deferred, depending on the IRA (Traditional IRA or Roth IRA).
There are many different ways that these methods can be combined. You aren’t limited to just one of them. You can choose to invest in more than one option to make the most of your investment money.
An LLC IRA can be used to directly purchase a property, find a partner, and get a non recourse loan. You aren’t limited to just one strategy. Different tax-advantaged accounts allow you to invest in different ways. For example, you can have two different IRAs. Keep that in mind when reading about each method.
Benefits of Using a Self-Directed IRA to Invest in Income Property
There are 3 benefits of using a self-directed IRA or 401k to invest in rental or income property:
- Simplicity of investment
- Ability to purchase at a discount
- Quality cash flow
I’ll explain each one of those in more detail.
Benefit #1: Simplicity of Investment
I am a VERY bad stock market investor. I think I’ve made every possible mistake. I have faced many challenges when it comes to stock investing, one of them being my lack of understanding when it comes to the financial details of the company I am investing in. When I look at corporate financial reports, it is difficult to understand because the language is very complicated.
But the beauty of rental properties is their simplicity. You can often do a rough calculation of rental costs without much effort, or you can take a course on spreadsheet software to get a more accurate estimate.
Zillow and Redfin are two popular online services that can help you estimate the value of a property for free. If you want an expert opinion on the value of your home, you can use a local real estate agent or appraiser.
Residential real estate values are relatively easy to understand. The house down the street that is similar in size and condition just sold for $200k, so it is probably worth a similar value. And the same common-sense rules apply to rental values.
Benefit #2: Ability to Purchase at a Discount
I have observed that there is a pattern among highly successful investors. They tend to buy their investment properties below market value.
It is difficult to buy a stock at a price below its current value in the stock market because it is such an efficient market. But real estate purchases at a discount are much more common.
The prices in the real estate market don’t always reflect the true value of the property. This occurs for many reasons, including fewer buyers competing to buy one house, less extensive information, and the emotional nature of real estate purchases for many sellers and buyers.
Benefit #3: Quality Cash Flow
The value of properties in Florida would often fluctuate dramatically when I was growing up. I remember condos on the beach that were selling for $150,000 in 2006 and they were on the market in 2010 for $40,000.
I fully respect the risks associated with real estate. I have been very cautious with my investments because I do not want to experience the same financial loss that my parents did when they were children during the Great Depression.
I was struck by how rents for properties did not change during the period when prices fell between 2006 and 2010. Rent prices are generally more stable than home prices because they are closely linked to the salaries of people in the area. However, there are some circumstances where rents could also decrease.
We found that concentrating on cash flow was a way to stay cautious as a real estate investor. My wife and I have been very lucky that our rental properties have become more valuable over the last few years. We’ve always bought property expecting that it wouldn’t appreciate. We did not expect the property to be profitable, but we thought it would generate a reasonable amount of money from rent.
We’ve made 8-10% returns on our investments. One of the benefits of investing in real estate through a self-directed IRA is that the returns are typically much higher than if you were investing in index funds or other stocks.
Real estate IRA strategies fall into five main categories:
- Direct Purchase
- LLC/Checkbook Control
- Non-Recourse Loan/Leveraging
- Mortgage notes
Making a Direct Purchase with Your IRA
Purchasing real estate through a self-directed IRA is most commonly done through a direct purchase. This is when your IRA account is used to purchase a property without having to use any additional money. Your IRA is making a purchase of real estate with all cash. This is the easiest and fastest way to fund a purchase. You would not normally get a loan to purchase a mutual fund, indexed fund, or precious metal. You would simply purchase it directly.
If you want to purchase real estate with your IRA, it’s similar to buying property with cash. The only difference is that the contracts for the purchase must be in your IRA’s name, and they must be signed by IRAR Trust on behalf of your IRA. Some things to keep in mind to avoid prohibited transactions: -Do not buy from or transact with any disqualified persons.
If you’re thinking of buying a home, it may be a good idea to find a real estate agent who is familiar with the home-buying process. feel free to contact us if your agent has any questions. We’d be happy to answer their questions.
If you are a real estate professional, you are allowed to represent your IRA in a transaction. However, you can’t receive any compensation. The same is true for any family member. The IRS prohibits taking a commission because it is a personal benefit to you.
To make sure your transaction goes smoothly, it’s a good idea to open and fund your account as soon as you have an investment in mind.
Partnering Your Self-Directed IRA (SDIRA)
If you don’t have enough money in your IRA to buy a property outright, does that mean you can’t buy the property? No! You can fund your IRA by partnering it with one or more other investors.
When you partner your IRA, you’re combining retirement funds to make an investment, similar to what you would do outside of an IRA. You can find a partner to invest with, whether it be another investor, an IRA, or even using your own funds (for a new transaction only, with more details in our partnering chapter). When you have an IRA, you can invest in real estate without having to pay the full purchase price upfront, or taking on any debt. You can use your IRA to work with people who are not allowed to invest in new projects. That isn’t a prohibited transaction. You can combine your retirement savings with the personal funds of your spouse or anyone else typically not allowed.
partners need to agree on how to divide expenses and income after someone buys a property. If a couple purchases a house together and each contributes an equal amount to the mortgage, they will probably have an easier time maintaining an equal financial relationship If a husband and wife use their IRAs to buy a condominium together, they will have to split all future income and expenses 50/50. If a couple purchases a house together and each contributes an equal amount to the mortgage, they will probably have an easier time maintaining an equal financial relationship.
Using an IRA LLC to Gain Checkbook Control
Another method that investors often use to invest their money is an IRA LLC. An IRA LLC is a limited liability company that has no other members except for the IRA. An LLC that is owned by one person is often called a single-member LLC. This type of LLC gives the owner more control over how the IRA funds are used. The advantage of having a Roth IRA is that you have complete control over your retirement funds.
With an IRA LLC, you can be in control of investments, expenses, and recordkeeping. The LLC is still owned by the IRA and is still subject to all IRA rules and regulations, even though you have more control over it.
You need to create an LLC that is owned by your IRA. IRAR doesn’t provide this service, but there are many online resources that do (or that can help you do it yourself). After you have successfully set up your LLC, you will need to open a business bank account in the LLC’s name. To form an LLC, you will need to obtain a Tax ID Number (EIN) from the IRS, as well as your Articles of Organization and Operating Agreement. You can set up a bank account for your LLC, which will give you more control over the money in your IRA.
In an IRA LLC, you can invest in a variety of assets. You have multiple options when it comes torental property, and this is just one strategy. Although you have more control over your business, you also have less oversight and you are responsible for any recording and reporting requirements, including tax filings.
Non-Recourse Loan & Leveraging
If you need more capital, you can take out a loan from your IRA. If you were to purchase a house, the loan you would receive would be different than the type of loan being discussed here. Your IRA needs a non-recourse loan.
In a traditional mortgage, you are personally guaranteeing the loan, meaning that if you default on the loan, the lender can come after your personal assets. In a non-recourse loan, you are not personally guaranteeing the loan, so if you default, the lender can only come after the property itself, not your personal assets. This means that the lender does not take your income or credit score into account when you apply for the loan, and they cannot take legal action against you if you fail to repay the loan. The person who has an IRA account will not be the one who has to repay the loan.
In the event of default or nonpayment, an IRA loan is the only collateral in the name of the IRA. The only recourse for the lender is to seize the property. They can’t go after additional IRAs or personal assets. The loan-to-value ratio is generally lower than most mortgages to make up for this.
Investing in Mortgage Notes With an IRA
A mortgage note is a document that states that the borrower promises to pay back a loan. The loan is secured by physical property. Basically, a mortgage is a loan in which you use property as collateral. The loan is secured by a note, which is a document that outlines the terms of the loan, including the amount of the loan, the interest rate, and when the loan is due. If the borrower doesn’t follow the terms of the note, they will face consequences like late fees, default, or seizure of collateral. The borrower pays the lender back directly instead of borrowing through the bank.
The note outlines the mortgage type, principal amount, repayment schedule, interest rates, and what happens in case of default.
Frequently Asked Questions (Lightning Round!)
Chad was kind enough to give feedback on some commonly asked questions regarding Self-Directed IRA’s. So, here are my answers – lighting round style!
Is a Self-Directed IRA a good idea?
If you’re not interested in being actively involved in creating your wealth, a self-directed IRA probably isn’t a good fit for you. It is in your best interest to invest in index funds or to seek the help of a financial advisor. A self-directed IRA is the best option if you want to invest in something specific, like a private stock offering or real estate.
Can you roll a Traditional or Roth IRA into a Self-Directed IRA?
Whether your account is a Roth or Traditional, you will still be the decision maker for the account and able to invest in alternative assets. The functionality of the account is identical.
What is a better investment, REITS or real estate through a self-directed IRA?
Although REITS can be helpful in building wealth, I think they are not as good as owning real estate directly for a few reasons.
First, REIT’s continuously dilute their share count. This decreases the amount of assets you own over time. REIT’s have a lower dividend yield than owning a rental property. Third, you could buy a relatively low-risk single-family home for cash. REITs are usually a collection of commercial buildings that have a lot of debt.
Of course, REITS also provide more diversification. So, there are always trade offs.
How much does it cost to set up a self-directed account?
If you heard about us through Coach Carson, we’ll waive the setup fee.
How much money can you put into a self-directed IRA on an annual basis?
The most common types of IRA accounts are Traditional and Roth IRA’s. If you are under 50 years old, you can contribute a maximum of $6,000 per year. For individuals aged 50 or over, the maximum contribution is $7,000. To contribute, your earned income must be equal to the amount you contribute.
Did this overview of self-Directed IRA’s and 401(k)’s help you out? This topic is a true passion of mine. I enjoy learning from investors like yourself and hearing about both your successes and failures.
I would like to thank Chad for letting me share this information. I would be happy to help anyone in this community in the future.
Thank you for taking the time to read this. I wish you the best of luck in achieving financial freedom, whether it comes through a self-directed account or not.