One of the best ways to both invest for your retirement and at the same time use your retirement funds to increase your wealth is to invest with before-tax funds in a Self-Directed Individual Retirement Account (SDIRA). Regular IRAs are typically limited to only certain investments, such as CDs and mutual funds. The SDIRA, however, allows you to make investment decisions and choose the assets you want to have placed in your portfolio. This means that you can invest in non-traditional investments like real estate. IRS regulations do require that a trustee or qualified custodian hold the IRA assets on your behalf, so be sure that the custodian you select does in fact allow real estate investments.
When investing in real estate through your IRA, technically, you aren’t the one buying the property it’s your IRA which is buying the property. In other words, your account owns the property and you own the account. This is an important point, especially when you’re ready to complete agreements and documents as you’ll need to list your IRA as the owner.
The term self-directed IRA isn’t a technical term; it merely means that your IRA is directed by you instead of someone else. You may get conflicting answers through various institutions who say they offer self-directed IRAs, yet restrict you from investing your IRA in the way you want. A “Truly” Self-Directed IRA (TSD IRA) is the term used to say there are no in-house custodial restrictions and you have ultimate flexibility and control without unnecessary restrictions imposed by your IRA custodian or trustee. It basically means you don’t have to check with a custodian of your IRA to see if they will allow you to make an unorthodox investment with your IRA funds like buying real estate. You have complete control and can buy and sell anything you wish through your IRA.
There are numerous benefits to setting up a SDIRA including that you can turn it into an LLC and gain the benefits of both tax-deferred income and liability protection. A self-directed IRA LLC is a modern hybrid between an Individual Retirement Account and a Limited Liability Company. The combination between these two types of legal entities will give investors iron clad asset protection, tax free growth on investments and freedom to make and maintain investment decisions and directions at will. Although you can use a TSD IRA for various investments, if you want real estate in your IRA portfolio the TSD IRA structure is an invaluable tool.
With a TSD IRA you will have the flexibility to move in and out of real estate deals before your competition can even make an offer. Remember, you are the boss, you have the final say. With a TSD IRA you have true checkbook control. Checkbook control means that you don’t have to get approval for your investments. You make the decisions, you sign the contract and you write the check. While your competitors who use regular IRA’s to purchase real estate are on the phone trying to either get their custodians to answer their calls or explain the nature of the deal to them, you have already made your offer and written a check for the down payment.
And there are some significant tax benefits to purchasing property through your TSD IRA as well. The earnings are tax-free at distribution compared to a traditional IRA where the distribution is taxed. So for example If you take a small amount, say $10,000 and parlay that into a half-million or a million dollars, in a traditional IRA you’d have to pay taxes on a million dollars whereas using your TSD IRA saves you tremendously.
Even better is if your SDIRA or TSD IRA doesn’t have enough money to pay for the entire purchase, you can finance or leverage any income-producing property already in the IRA to cover the difference. The property is the collateral for the loan. As the property is an asset of the retirement plan, repayment of the underlying debt must come from contributions to or income from the property or other assets in the retirement plan. This type of loan is generally referred to as a non-recourse loan because the IRA holder cannot extend credit to an IRA. In essence you are using your IRA to buy the property and at the same time using the property as collateral to pay back your IRA for any additional monies the property may cost you. It really does seem too good to be true. You get to be your own lender.
As always you should talk to a knowledgeable financial specialist regarding your situation before deciding on whether setting up an SDIRA or TSD IRA is right for you.
Daniel Doran is a 20+ year veteran in the real estate industry. He is a previous owner of a law firm, mortgage and title company. Daniel has also written several books on mortgage modification, short sales and real estate investing. He currently specializes in Commercial Finance and Real Estate Development and is a graduate of Manhattanville College and Brooklyn Law School. You can contact Dan at Buildings By Owner