5 Things To Keep In Mind Before Buying Real Estate Using Self-Directed IR
There are many benefits of buying real estate using a self directed IRA. The biggest among them is the tax-free growth it offers. For instance, if you purchase a piece of land or a house using $80,000 of your retirement funds and later sell this property at $300,000, the profit of $22,000 you’ll gain will be free from any tax.
On the other hand, if you purchase the same property using non-retirement funds, you’ll have to pay the taxes incurred on the gains. In most cases, it will be subjected to state income tax. Another advantage of using a self directed IRA is that it allows you to invest in the assets you know and understand. This includes investing in hard assets such as a plot of land or a rental property.
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Finally, SDIRA enables you to diversify your investment by investing in alternative assets. However, before investing in real estate with SDIRA, there are five important things to keep in mind:
Perform A Solid Research
Investing in real estate is an important decision that should be taken after proper planning and research. It involves taking a number of things into consideration. Hence, it is very important to take your time and perform solid research on the type of property you’re planning to purchase using an IRA.
It is very important to make yourself familiar with the components like cost, terms and conditions, permissions, taxes etc.
Pay Attention To The Cost
Investing in real estate is different from investing in mutual funds or stocks. Purchasing real estate involves a variety of ongoing costs like taxes, repair and maintenance. Hence, it is important to ensure in advance that the property you’re planning to invest in can be afforded by your IRA. A good idea is to reserve at least 5 to 10 percent of the complete value of the property.
Have A Look At The self directed IRA Custodian Option
The majority of banks and other financial institutions don’t allow their customers to purchase real estate using an IRA. The reasons behind this is, it does not generate any profit for the bank or other institutions.And this is where self-directed custodians come into play.
Your self-directed custodian will help you to make mindful asset investments using your retirement funds. There are basically two options while purchasing real estate using a self directed IRA: Custodian controlled SDIRA and Checkbook Controlled self directed IRA.
With the custodian controlled, self directed IRA allows the IRA holder to direct his custodian to invest his retirement funds into a variety of real estate options including traditional as well as alternative assets.
The “Custodian Controlled” self directed IRA method is preferred by IRA holders planning to invest in alternative assets investment that doesn’t involve investing in high-frequency transactions such as a piece of land or an investment fund.
Understand The Rules And Regulations
The deal with IRC (Internal Revenue Code) is that it doesn’t state what and where a self directed IRA can invest in, it only mentions the areas where it cannot invest. For instance, Code Sections 4975 and 408 restricts the “disqualified individual” from investing in certain types of assets.
All in all, as long as the IRA is not used to purchase collectibles, life insurance policies or involve in a transaction that results in benefitting the IRA holder, then the investment is permitted.
Leverage May Result In Higher Taxes
Generally, the IRS prohibited rules forbids the IRA holders to guarantee personal loans associated with their IRA. However, if an IRA holder secures a loan that is not guaranteed by him or a non-recourse loan, to purchase a property with IRA, it may trigger the Unrelated Business Taxable Income (UBTI) regulations and taxes as high as 37% could incur.
So, these are some of the most important things one should keep in mind before buying real estate using a self directed IRA. This option is gaining more and more popularity due to its tax and other benefits.
However, it is very important to invest your retirement funds mindfully especially when it comes to investing in real estate. We hope this guide helps you in doing the same and making a mindful investment using your IRA.