How to Invest With a Real Estate IRA
How to Invest With a Real Estate IRA
Many people who open individual retirement accounts will use their assets to invest in mutual funds, exchange-traded funds, stocks, or bonds. However, it’s possible to create an IRA account that’s focused on holding real estate investments. Once you open this account, you can invest in apartment buildings, single-family homes, retail stores, office complexes, hotels, and raw land. There are, however, extensive rules and guidelines that play a part in how you can invest in real estate with an IRA, all of which you’ll need to be aware of.
Using the Right IRA Account to Purchase Investment Property
The first, and likely most, important thing you should understand about investing with a real estate IRA is that it must be a self-directed IRA. This type of IRA is a retirement account where alternative investments are fully accepted. These investments can include everything from precious metals to real estate. When you create a self-directed IRA, this account will be independent of a bank, investment company, or brokerage that would otherwise be able to make decisions for you.
If you want to invest in real estate with your self-directed IRA, you must obtain a custodian for the account, which is someone who will manage your transactions, any paperwork, and all financial reporting to the IRS. Every action you take with your self-directed IRA will go through the custodian you hire to make sure that the strict guidelines surrounding real estate IRAs are adhered to.
Keep in mind that the custodian you hire will only be responsible for handling the documentation and back-office tasks that must be performed with a self-directed IRA. they won’t provide you with guidance on what types of properties to invest in or how to structure your account. Before you create a real estate IRA, one rule that you must understand is that the IRA will own the property as opposed to yourself. The property you invest in must be used solely as an investment as opposed to a second home or a vacation home.
Buying and Managing Your Investments
Using your self-directed IRA to purchase investment properties is an effective form of real estate investing. Because of its complexities, however, this type of investment isn’t for everyone. An essential consideration that you must take into account is how to purchase the real estate that you’ll hold in a self-directed IRA. The balance in your account must be relatively high before you’ll be able to obtain a mortgage. You may be required to pay for your investment in cash, which can substantially reduce the amount of funds in your IRA.
While some banks and other financial institutions provide loans for this kind of transaction, keep in mind that all revenues you bring in from your investment could be treated as unrelated business taxable income. Since an IRA account can’t be used to pay taxes, you won’t be able to benefit from the tax deductions that real estate owners usually have access to. Because cash has been paid for this property, there won’t be any interest payments to deduct. In the event that your property generates any amount of income, this income will go back into your IRA since you don’t own the property.
While you can’t deduct taxes when owning real estate through an IRA, your costs won’t be as high since the IRA account will pay for any expenses related to managing the property, which can include maintenance. However, it’s also essential that you have enough funds in your IRA account to cover maintenance expenses.
Pros and Cons of Using Your IRA to Invest in Real Estate
Before you create a real estate IRA, you should weigh the pros and cons of this investment option. One of the main reasons why real estate IRAs have become increasingly popular over the past 5-10 years is because of the consistent strength of the market, which has allowed real estate to be a great long-term investment. Property values tend to increase over time, which is ideal for long-term retirement accounts. The main benefits of having a real estate IRA include:
• You’ll be able to diversify your investment portfolio
• Real estate tends to appreciate over time
• You can flip, buy, and sell investment properties
• Real estate may be able to provide a consistent income stream
The main drawbacks to this type of account include:
• A self-directed IRA must be created, which involves hiring a custodian
• Deductions can’t be claimed for mortgage interest, property taxes, or depreciation
• You can’t live in the property
• All maintenance and repair costs need to be paid with money from your IRA
Investing with a real estate IRA is a great option when you want to build your wealth and diversify your investment portfolio. When creating this account, focus on hiring a custodian who will make sure that the account itself is following all of the rules associated with a real estate IRA.