Almost every American working in the private sector knows that the good old days of corporate pensions are permanently in the rearview mirror. This has led the government to take several steps to encourage Americans to save for retirement.
One of them is an Individual Retirement Account (IRA), an investment in which workers can invest up to $5,000 of their annual pre-tax income to grow their wealth by using that money to take advantage of various employment opportunities. ‘investment.
IRAs have proven to be popular investment vehicles, but they have certain restrictions on which investments you can take advantage of. For a long time, many IRA custodians did not allow accounts to take advantage of alternative investments like real estate. It also meant that there weren’t many real estate offers for IRA holders.
However, that has changed and there are a growing number of real estate offerings that accept IRA contributions. You can also convert part (or all) of your traditional IRA to a self-directed IRA. Self-directed IRAs offer investors the ability to invest in real estate, but with some restrictions. Keep reading to learn more about how to boost your IRA returns with real estate investments.
What is a self-directed IRA?
An easy way to invest in real estate with an IRA is to use a self-directed IRA. A self-directed IRA works like any other IRA account with a few notable exceptions. Under a standard IRA, you put your money in an IRA and the fund manager grows your wealth by investing it in various traditional investment offerings such as stocks and bonds. However, in a self-directed IRA, you make the decisions about the investments you make.
Self-directed IRAs give you more freedom to invest your money in alternative investments like real estate. Remember, though, that even with a self-directed IRA, you’re still limited to investments authorized by your IRA’s custodian (account manager). So before you start investing in real estate, be sure to turn your existing IRA (or start your IRA) into one with a custodian that allows real estate investments.
Options for investing in real estate with your self-directed IRA
Once you’ve launched your self-directed IRA, the next step is to determine the type of real estate investment you want to make. Before you decide to buy an investment property, there are a few things to consider. First, you will need to purchase the flat property. You cannot get a mortgage on property purchased by an IRA. You will have to buy the property you want in full without financing.
Why? This is because of IRA rules that prevent personal transactions. Remember that IRAs are designed to help you store your pre-tax income until retirement. As a result, they have prohibitions on so-called personal transactions, which use IRA funds for any immediate tangible benefit. Using your after-tax income to make mortgage payments on property in your self-directed IRA counts as a personal transaction under IRA rules.
Once the property is in your self-directed IRA, you can do one of three things:
- You can hold the property until it appreciates and sell it.
- You can upgrade a distressed or obsolete property that you bought cheaply and then resell it – a practice known as flipping.
- You can rent the property for short or long term.
Keep in mind that regardless of how you choose to make money with your self-directed IRA real estate, you are prohibited from using anything other than your IRA funds to make any necessary improvements, repairs, or pay other property-related expenses.
The same applies to the profits you make or the rents you collect. All funds must come from or go directly into your self-directed IRA.
Spending even a penny of your profits or investing a penny of your own money in spending is considered insider trading. If you violate this prohibition, your self-directed IRA funds will no longer be tax-deferred and you will face a hefty tax bill.
Other Personal Transaction Prohibitions
Investing your own money or spending non-IRA funds in your self-directed IRA’s real estate aren’t the only self-dealing violations you should be aware of. When in doubt, remember that you can never benefit directly from an ownership-related transaction in your self-directed IRA.
It also means that you cannot buy property from a disqualified person, which is one of the following:
- Your parents
- your children
- Your partner
- Any other family member
- The custodian of your self-directed IRA or any professional who provides services for the IRA, such as your accountant, attorney, or servicer
The title to the property in your self-directed IRA must show the self-directed IRA — not you — as the owner. Your self-directed IRA cannot purchase property that you already own. You are also prohibited from operating as a property manager – onsite or offsite – if you use your self-managed IRA property for rental income. You must hire a third-party management company that is not run by a disqualified person.
If you’re unsure about a specific transaction or expense related to your self-directed IRA, check with your custodian. This could save you from making a costly mistake.
An easier way to invest in real estate with your self-directed IRA
The rules on personal transactions with IRAs are meant to be strict. The government wants a strong firewall between the tax-deferred funds in your self-directed IRA and any money or real estate you already have access to. On top of that, buying free and clear property with your self-directed IRA funds will likely cost six figures, even in an affordable real estate market. This could represent a significant portion of your IRA funds.
Fortunately, there is a better and more efficient way to invest in real estate with your self-directed IRA than researching properties and buying them with your self-directed IRA. The real estate crowdfunding world has opened up a wide variety of options. Many real estate investment platforms have offerings that will accept both traditional and self-directed IRA contributions.
Fundrise is one of the most popular and respected real estate crowdfunding platforms. It was put together by a team of established real estate professionals who wanted to simplify building a real estate portfolio. This is a great place to start investing your IRA in real estate because Fundrise has its own IRA.
It’s true. You can transfer part – or all – of your IRA into a fund made up of a diversified portfolio of real estate assets chosen by the braintrust Fundrise. All of the fund’s assets were chosen for their unique combination of upside potential, ability to withstand market downturns and projected ability to generate long-term profits for investors.
It doesn’t get much easier than set it and forget it, and the Fundrise IRA lets you do just that. You don’t have to worry about accidentally violating the insider provisions, and Fundrise will do the accounting, pay the distributions and issue the statements.
CalTier is another widely respected real estate platform with two fund options that accept IRA contributions. Its multifamily fund is set up to seek out B- and C-rated multifamily properties in the growing southern and western US markets.
The multi-family fund focuses on adding value to properties by making management more efficient, improving units and increasing rents. You can buy into the fund for as little as $500, and the fund expects an annual return of 8%. Investors will benefit from both passive income on rents and property appreciation when CalTier sells the fund’s assets.
If you’re the type of investor who enjoys the challenge of choosing your own offerings and controlling where your self-directed IRA assets go, CrowdStreet may be a great option for you. It’s one of the leading real estate investment platforms online and has an impressive array of offerings that accept both IRA and self-directed contributions.
The Crowdstreet Opportunistic Fund I LLC is accepting contributions from investors to purchase between eight and 10 commercial properties with high, long-term income potential. The portfolio’s assets will be spread across several real estate sectors, including multifamily and industrial. If the opportunity arises, the fund can also acquire housing, shops or offices.
The fund has a minimum buy-in of $100,000 and a holding period of three to seven years. It projects an internal rate of return of 18% to 22%, and distributions will be paid to your self-directed IRA on a quarterly basis. So if you wanted to go for an aggressive fund with assets managed by CrowdStreet’s advisory team, the Opportunist fund is worth considering.
Additionally, CrowdStreet is always posting new deals on individual assets in the multi-family, industrial and commercial sectors. The average minimum investment for these offerings is around $25,000, and each has its own risk profile and projected return. So even if you don’t like funds with someone else’s chosen assets, CrowdStreet has plenty of real estate options for your self-directed or traditional IRA.
No shortage of options
As you can see, there is no shortage of quality options for self-directed IRA holders when it comes to real estate. You can choose your own individual properties for flipping or passive income. You can also choose from a large menu of funds and individual offerings from some of the many real estate crowdfunding platforms open to you.
No matter how you decide to add real estate to your IRA or self-directed IRA, your equation as an investor remains the same. You should carefully consider your investment objectives and be as familiar with the potential risks of an investment as you are with the benefits. Consult with a financial advisor and the custodian of your IRA. Invest wisely. Hopefully real estate will prove to be a perfect complement to your IRA.