A less well-known but advantageous type of retirement account ideal for real estate investments is the self-directed IRA. They’re tailored for people who want to acquire real property to build wealth strictly for retirement. It’s also the most hands-off way to manage rental properties with important tax benefits.
The self-directed IRA account differs considerably from other kinds of retirement vehicles in that it must be administered by a third-party custodian and its funds are untouchable until the age of 59 ½. Investments in real property of any kind, precious metals, notes, private placements and others are allowed under these accounts.
The custodian is usually a bank or financial institution who will accept and disburse payments, and report the activity to the IRS. Once you open the account, you can monitor the activity and make deposits, but you can’t withdraw any funds without penalties. As the profits grow, you can invest some of the balance in real estate and other ventures.
Once funded, you can acquire property through the IRA. It’s possible to mortgage it as long as the loan is non-recourse. You’ll have to fund the account to cover all the expenses up front, and fund administrators recommend that the IRA have at least six months of operating expenses.
This type of IRA lets you invest in real estate as a tax-deferred way to fund your retirement. They’re particularly advantageous for those who expect their incomes to be substantially lower upon retirement and a lower tax bracket reduces the liability.
Since the rules surrounding these IRAs require a hands-off approach, it favors investors who use property management companies. Owner participation in the property’s care and management is limited to prevent self-dealing.
The IRS takes a dim view of using self-directed IRAs for self-dealing and the custodian of the account handles all the accounting and reporting. Between the hands-off policy regarding property and financial management, these self-directed IRA accounts are well-suited for someone looking for a passive means to build an income stream after age 60.
It’s also possible to partner with others. Your portion of the IRA will stand alone, and the partner’s funds will be treated separately. This provision helps you acquire a property for your IRA earlier than you would otherwise.
Like all retirement accounts, self-directed IRAs enjoy full protection under state and federal bankruptcy laws, since they’re basically trusts. Outside of the protections, you’ll be able to take advantage of a higher overall rate of return that real estate investments generally achieve.
Properties you already own don’t qualify, nor does property owned by family members.
All returns from the investment must be for retirement. As your account grows, you’ll be able to reinvest in other properties to add to the account, but you won’t be able to move money out without a penalty until you reach retirement age.
Income made from mortgaged property is taxable.
You won’t be able to use the property as a second home or perform any work on site.
Real estate investments made through a self-directed IRA offer plenty of advantages for wealth building and tax deferral. Although the terms for these kinds of retirement accounts are strict and detailed, their structure places much of the time-consuming work in the hands of others. When it’s time to withdraw, you’ll have earned a generous return.
See also Can You Buy Real Estate with an IRA?
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