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How to Invest in Real Estate With a Self-Directed IRA

How to Invest in Real Estate With a Self-Directed IRA

Did you know that you can use self-directed IRAs to purchase investment property? It’s true. The IRS permits retirement accounts like IRAs to invest in real estate, among other options. There are a lot of advantages to using a self-directed IRA, or a solo 401(k) plan, to buy real estate. The first advantage is tax deferral (or tax-free growth).

If you were to purchase a $250,000 property with retirement funds, and later sell that property for $450,000, the $200,000 profit you earned would, generally, be tax-deferred. 

Alternatively, gains earned from an investment property purchased with personal funds would be subject to federal and state income tax. 

The second advantage is that a self-directed IRA can allow you to invest in hard assets you know and understand, such as rental property. 

Finally, having the ability to invest in alternative assets outside of the stock market is believed to be a great source of investment diversification. 

“Always become familiar with the locality, rental rates, and the costs involved with purchasing and holding property before investing in real estate using an IRA.”

But before buying real estate in Utah with a self-directed IRA, there are three things you should consider. 

1. Research. It’s important that you do your due diligence on the real estate asset you plan to purchase with your IRA. This means you should become familiar with the locality, rental rates, and the costs involved with purchasing and holding real estate as an investment.

2. Price. Unlike stocks or mutual funds, which typically don’t have ongoing costs, real estate investments will carry expenses like property taxes, maintenance costs, and insurance fees. Keeping a three-month reserve of funds for each investment property is advisable, as this will help you cover vacancies and repairs. 

3. IRA custodian options. Most traditional financial institutions and banks don’t allow IRA holders to buy real estate with their investment account, since it doesn’t generate a profit for the institution. However, there are a number of self-directed IRA custodians throughout Utah, and the United States as a whole, that allow clients to make alternative investments like real estate. There are essentially two options you have if you plan to purchase investment property with your IRA. Your first option is a custodian-controlled self-directed IRA, and your second is a checkbook-controlled self-directed IRA. 

In a custodian-controlled IRA, the holder will direct the custodian to invest in traditional and alternative assets. A checkbook-controlled IRA, meanwhile, requires that a special-purpose LLC is established. This LLC would be wholly owned and managed through a local bank account by the IRA holder. The use of the LLC allows the holder to act quickly and cost-effectively when the right investment opportunity presents itself. 

The custodian-controlled option is often used by IRA investors looking to make alternative investments without a high frequency of transactions, like the purchase of raw property. The checkbook-controlled option is popular among IRA investors interested in making real estate investments with a high frequency of transactions, such as rental properties or fix-and-flip projects. 

While using a self-directed IRA to invest in real estate is becoming more popular, it’s still important to think about the benefits and considerations mentioned today. We also recommend consulting with a tax professional for further guidance. 

If you have any other questions or would like more information, feel free to give us a call or send us an email. We look forward to hearing from you soon.

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