One of the first things I learned about when I was considering getting into real estate investing was the self-directed IRA. If you have never heard of such a thing, a self-directed IRA is very similar to the more “traditional” IRAs that most associate with their jobs. The main difference is your investment choices are not limited with a self-directed IRA. With a self-directed IRA, the sky is almost the limit.
A self-directed IRA is just that, self directed. You make the choice of where to invest your money. If you wish, you can go the traditional route and invest in stocks, bonds or mutual funds or you can buy real estate, make loans, purchase options or notes and a whole host of other things. Like I said, the sky is almost the limit. This sounded great to me, so I opened one up and have been using it to invest in real estate ever since.
When I was still in the “working” world, I had several of the more traditional type IRAs with investments in stocks and mutual funds. And they were doing OK. Before I went into full time investing, I set up mu self-directed IRA and began contributing immediately. There were a couple of reasons for that:
- It is easier to set up when you have a job and job related income.
- Once I quit, I could no longer contribute rental income towards and IRA (rental income is passive income and is not allowed to be placed in an IRA). So I was able to build up a little bit of a slush fund so to speak.
After I went into investing full time, I discovered another advantage. Since I was no longer employed, I could now roll over all of the funds from my other, job related IRAs into my self-directed IRA. This action created a nice lump sum for me to invest with. But be warned, the companies managing your IRAs do not like to let you leave. They erect many barriers and roadblocks. Just be persistent and you will win.
Today I have several rental properties held by my IRA. These were purchased with the cash I had saved and rolled over. I looked into leveraging this cash by getting a loan, and while it is possible to do, you may shoot yourself n the foot due to something called Unrelated Business Income Taxes (UBIT). So talk with a trusted CPA before you do that.
I strongly recommend any real estate investor look at the potential of a self-directed IRA. The returns can be phenomenal and potentially tax free! You just need to find a custodian to help you get set up. I use Equity Trust and have been very happy with their service. But shop around as there are several custodians out there.
If you do set up a self-directed IRA (and I hope you do), here are some tips for you:
- Keep some cash inside it for repairs and maintenance. You cannot co-mingle your own funds with IRA funds. Any repairs needed to a property held by your IRA must be paid for by your IRA.
- Invest jointly with your spouse. You can, for example contribute 50% towards a property and your spouse can do the same out of their IRA. It is a good way to make your dollar go a little farther.
- Mix things up a bit. Buy some rental properties. Make some loans. Purchase an option. Spread out the risk.
So look into a self-directed IRA. Trust me; you will be glad you did.
Anyone got a good self-directed IRA story out there? Had a huge tax free return or score a big deal? Let us know with your comments.
Nice summary post Kev. Several of my investor use self directed IRAs. They are a very nice tool.
Thanks Al!
As always, I appreciate your comments,
Kevin
Great information, Kevin! I also would recommend “The Self-Directed IRA Handbook” by Mat Sorensen. It’s the definitive resource in this area for those who are setting up their own SDIRA or for those who are using them as a vehicle for funding. I’m trying to set up my real estate business in Kentucky and plan on using the SDIRA as a way to obtain private funding for deals.
So, are tax benefits the only reason for using an IRA for REI? I’m too young to have wrapped my mind around this… Why would I put my savings into a self-directed IRA instead of purchasing additional properties directly?
Jenna, I think the major benefit is the tax deferments and avoidance. The cash flow from your rental grows inside the SDIRA tax-free. This can allow you personally a good (and passive) return on your investment that can set you up for both your own retirement and the passing on of your wealth to your family after death. Depending on how you set up the IRA, you can delay or completely defer paying taxes on the cash flow generated by your rental.
All that said, this should be done strategically–so I don’t think the question is whether you should or shouldn’t buy new properties within a SDIRA. Rather, in my view you would develop a strategy based on your retirement goals, divert a percentage of your income into a SDIRA and then once you had saved the appropriate amount, purchase the number of properties you need to reach your goal. While this is going on you would still be operating your RE business like normal, which could include purchasing properties outside of the SDIRA structure. But note that you will end up paying some level of income tax on the income from these rentals.
This is a complete oversimplification and know that there are many nuances that I’ve glossed over here. But I hope that’s helpful in at least outlining some of the considerations.
Caleb,
Thanks for the great reply and for adding to the discussion.
Kevin
Jenna,
You are not too young! Start Now!
Caleb wrote a nice response, but yes basically when you get older and start to pull the money out it can be tax free. Plus it can grow tax free over all those years. That is and will be a great benefit.
Start now, even if it is just a little each month.
Kevin