Why Real Estate is the Number One Investment in a Self-Directed IRA

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Folks have plenty of options to choose from when it comes to tax-advantaged retirement accounts. From 401(k)s to various IRA accounts, investors can leverage a diverse range of asset classes to put themselves in the best financial position possible. However, certain account types limit the selection of available asset classes. 

A standard IRA or 401(k) at a big bank like Fidelity or Wells Fargo, limits the range of choices to publicly traded assets like stocks, bonds, mutual funds, and ETFs. Through a self-directed IRA (SDIRA), investors can leverage alternative investment types like real estate. Let’s take a look at why leveraging a real estate IRA is the number one investment choice for SDIRA account holders.

What is a Self-Directed IRA?

Self-directed IRAs put the account holder in the driver’s seat. While the account must be held through a regulated IRA custodian or trust company, investors are able to direct funds themselves.

Why would someone choose this type of retirement plan? SDIRAs are tax-advantaged, meaning the earnings grow tax-deferred, and remain untaxed until withdrawals are made by the account holder. If in a Roth IRA, investments grow tax-free.

Besides giving investors freedom and control over their own assets, SDIRAs also come with a variety of alternative investment options, like real estate, for investors to choose from.

Why Use your Self-Directed IRA to Invest in Real Estate?

With reality tv shows like Selling Sunset and Property Brothers demonstrating the profitability of the real estate industry, it’s hard to ignore the potential return on investment (ROI) available through this market compared to the stock market.

Residential rental properties alone have an average ROI of 10.6%. But neighborhood houses are not the only real estate options available to investors. Investors can invest in several lucrative real estate options, such as:

  • Commercial real estate. Malls, shopping centers, or any property exclusively used for business-related purposes as workspace constitutes commercial real estate investments. Commercial real estate also produces a commendable ROI on average in the US, clocking in at 9.5%.
  • Residential real estate. Built-in equity isn’t the only way to leverage housing investments. The housing industry is booming and in high demand. Investors have the opportunity to grab a piece of the pie when investing in residential real estate through a self-directed IRA.
  • Real Estate Owned (REO) Properties. An REO is a type of property owned by a lender, such as a bank, that has not been successfully sold at a foreclosure auction. The transaction is usually conducted by a financial institution, like Fannie Mae or Freddie Mac, which will not create a conflict of interest with the business.
  • Real Estate Investment Trusts (REITs) are a type of real estate investment trust that allows anyone to own or finance properties through the purchase of stock. Individual investors receive returns proportionate to the percentage of funds they initially invested.
  • Land. Undeveloped land offers great potential down the line to generate income once a property is developed and sold.
  • Tax liens. Investors can indirectly invest in real estate through tax liens. They can act as a consistent source of income and be sold again later at a higher value.
  • Storage. The storage industry has an average annual revenue of $39.5 billion. Nearly 10% of households in the US rent a storage unit, making this less glamorous option an optimal real estate investment candidate.
  • Joint venture. Joint ventures allow individual investors to pool resources for a specific development or real estate investment. Building bonds, leases, and offshore properties are also other joint option ventures available that can generate a significant ROI.

As you can see, investment property is not the only alternative asset that your IRA funds can invest in. As always, we recommend you do your due diligence on any asset before opening a self-directed IRA.

How Do You Use Your Self-Directed IRA to Invest in Real Estate?

Real estate can be a powerful vehicle to build wealth and financial independence long term. Because self-directed IRAs are subject to the full discretion of the investor, it is imperative for account holders to know the ins and outs of how to invest in real estate through their accounts.

First, account holders must fund all real estate transactions through their SDIRA. These transactions are known as arms-length transactions. In this transaction type, the buyer and seller act independently and have no relationship with each other. Expenses cannot be paid using personal funds and investors are not allowed to work on the property themselves. All expenses must be paid using the IRA account and any renovations must be done through a third party.  See more on prohibited transactions.

Second, any income or profits generated from a real estate investment or sale, including a rental property, must go back into the IRA. The subsequent funds can then be reinvested into another real estate investment.

Once the account holder hits 59 and a half, funds can be withdrawn. Funds taken out before this time will result in a 10% penalty fee issued by the IRS. This can also depend on the type of IRA you have.

Additionally, some real estate investments with a non-recourse loan may incur a UBTI tax. If this is the case, the investor will need to file a Form 990-T.

How Can IRAR Help with your Real Estate IRA?

Having more control over your investment decisions can be a blessing or a curse. On the one hand, it is liberating to be able to freely choose your own investments. On the other hand, navigating which asset classes to choose from can seem daunting and overwhelming. While self-directed IRA custodians cannot offer financial advice like a traditional or online brokerage, we are able to provide educational resources the account holder can seek on their own. 

For nearly 30 years, IRAR has empowered people to build wealth through alternative investments at a lower cost. Book a free consultation with one of our experts today to learn more about setting up a self-directed IRA and the investment options available to plan for your future and financial freedom.

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