A Self-Directed IRA allows for alternative investments, including real estate. However, are you allowed to use seller financing when buying a property with your IRA? In the following, we will discuss the benefits of the Self-Directed IRA, why real estate investing is popular and whether or not you can use seller financing to make an investment.
- Seller financing is when the seller of the real estate property handles the mortgage process
- Real estate, including that involving seller financing, can be done with an IRA
- So long as you abide by the IRS rules, you can take advantage of the tax benefits of the plan
Can I Invest in Real Estate with my IRA?
You can make real estate investments with your IRA. In fact, the IRS has always allowed investors to hold real estate in their retirement account, yet many investors use their IRA to invest in bank CDs, the stock market or other traditional assets. This is because banks and traditional financial institutions limit their clients to the financial products they sell, which does not include alternative assets, like real estate. When you establish a Self-Directed IRA through an IRA custodian, you have the freedom to invest in real estate and other alternative investments along with traditional investments. The Self-Directed IRA structure is perfectly legal. It is similar to a Traditional IRA but allows you to diversify your retirement investments so they do not move in the same direction. The IRS permits you to engage in virtually any type of real estate investment as long as it does not include a disqualified person, such as yourself and lineal descendants.
What is a Self-Directed IRA?
A Self-Directed IRA, or in this case, a Real Estate IRA, allows you to invest in any type of asset which is not prohibited by the IRS. The only prohibited transaction that you need to worry about with a real estate investment is the disqualified persons rule. Essentially, you (the IRA owner), your spouse, your lineal ascendants and descendants, their spouses and entities controlled by such persons are not allowed to benefit from the investment. The Self-Directed IRA should be the only thing that receives a benefit, which are the tax advantages of the plan.
The Self-Directed IRA is one of few choices for those wishing to invest in alternatives. Traditional plans offered by banks and other institutions limit your investments choices. Typically, you can only invest in stocks, bonds, mutual funds and the like. Therefore, you must first set up a Self-Directed IRA in order to make real estate investments. Further, when using the right custodian, such as IRA Financial Trust, you can gain checkbook control of your funds. You never have to ask IRA Financial when you wish to make an investment. Other custodians require custodial consent for every investment you wish to make. This is very bad for real estate investors. Delays in the process could cause you to lose out on a property you wish to purchase.
Real Estate in a Self-Directed IRA
A Self-Directed IRA through a passive custodian is a traditional IRA that allows you to make IRS approved investments using your retirement funds. Investments you can purchase with a Self-Directed IRA include alternative assets, such as real estate. Some refer to a Self-Directed IRA for real estate as a “real estate IRA.” Although a real-estate IRA is a Self-Directed IRA, the investor primarily holds real-estate in his or her portfolio. However, Self-Directed IRAs allow you to invest in a wide range of alternative investments including gold, cryptocurrencies, private placements, and more. Furthermore, not all Self-Directed IRAs allow individuals to invest in real estate. Instead, some offer limited options, allowing IRA holders to only purchase cryptocurrencies and gold. Hence, if you are interested in investing in real estate, it is important to find a Self-Directed custodian, like IRA Financial that gives you an extensive range of alternative investment opportunities.
As with a Traditional IRA, all investments are either tax-deferred or tax-exempt with a Self-Directed IRA. Tax-deferral essentially means you do not have to pay taxes immediately. You can pay at a later date and allow the investment to grow unhindered until you take a qualified distribution.
Let us take a look at the power of tax-deferral when investing with a retirement plan. Assume you establish your retirement plan with $100,000 and you keep it open for 20 years. If you generate an average annual pretax rate return of 8% and the average tax rate is 25%, your investment will be worth $466,098 after 20 years. After taxes, you receive $349,572 on the earnings. Over the years, your investment compounds by re-investing your original investment.
Ideally, you should begin real estate investing when you are earning higher income and in a higher tax bracket. That way, when you reach retirement age and you can take a distribution, you most likely earn less income or no income, therefore in a lower tax bracket. In other words, you take more money home.
What Real Estate Investments Can I Make with a Self-Directed IRA?
Below is a partial list of domestic or foreign real estate-related investments you can make with a Self-Directed IRA:
- Raw land
- Residential homes
- Commercial property
- Apartments
- Duplexes
- Condos/town homes
- Seller Financing
- Fractional Real Estate
- Rental properties
- Mobile homes
- Real estate notes
- Real estate purchase options
- Tax liens certificates
- Tax deeds
Investing in Real Estate with an IRA LLC is quick and easy. When you see an investment you want, simply write a check, wire the funds or use a debit card. It is essentially the same as purchasing real estate personally, but with the added benefit of tax-deferral.
While you may open real estate IRA with retirement funds, IRA Financial Group does prevent you from investing in other alternative and traditional investments. It is important to note that some Self-Directed IRA custodians only allow you to invest in certain alternative investments.
Read More: What Can I Invest in with a Self-Directed IRA?
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How a Self-Directed IRA for Real Estate Works
Obviously, you need to first set up a Self-Directed IRA with your chosen custodian. Once it is established, you can then fund the plan. This can be doing by rolling over previous retirement plan funds, or by directly contributing to the plan. Note that the annual contribution limit for an IRA for 2020 is only $6,000 ($7,000 if you are at least 50). Therefore, it’s best if you have accumulated savings in another plan that you can move to your new Self-Directed IRA.
Learn More: Self-Directed IRA Rollover
Time to Invest
Once the plan is created and funded, it’s time to find your investment. Of course, this is up to you and any professionals you may hire, such as a realtor, financial advisor or planner. Once you find the ideal property, you are ready to make the investment. Since you have checkbook control, you can use a checking account, bank wire or debit card associated with the account to purchase the property. Once the investment is made, you can choose what to do with it. Will you fix and flip? Use it as a rental property? Is it a commercial space you will lease out? Or maybe you will develop a new real estate project. Whatever the case may be, the advantages of owning it with your IRA are huge.
All gains and income generated from the property flow back into your Self-Directed IRA. This means you pay no taxes until you start withdrawing funds from the plan during retirement. In fact, if you have a Roth IRA, all qualified distributions are tax free!
Related: Self Directed IRA Investments
Be Careful!
Again, it’s important to be mindful of the prohibited transaction rules. Never utilize the services of a disqualified person. Also, never sell, rent or lease the property to such persons. For example, you cannot rent a vacation property to your son for the week. Since he is a lineal descendant, he is a disqualified person. However, you can rent it to your sister, cousin, friend or neighbor. They are not disqualified persons under IRC 4975.
Related: Solo 401(k) for Real Estate
Get Started in Real Estate Investing with Your IRA
Getting started in real estate investing requires expertise, background knowledge and motivation. The level of each will vary whether you choose to make direct or indirect real estate investments. You have the option of using personal funds and retirement funds when making a real estate investment. When you use a retirement plan, such as the Self-Directed IRA, tax on the investments will be deferred or completely eliminated in the case of a Self-Directed Roth IRA.
Many of us are aware of the financial perks that come with real estate investing. The ability to gain a steady cash flow through rental income and its financial security makes it an attractive investment opportunity. During times of inflation, real estate thrives through increased property value and the rise of rental income while the value of many other investments erode.
Whether you see real estate investing as a means to quit your 9-5 and go into business for yourself, or to supplement your current job, it is an opportunity to generate higher, more predictable returns and have more control over the investment than other asset classes, such as stock.
If you are an investor who wants to get started in real estate investing, you can directly purchase real estate or indirectly invest in real estate properties.
Types of Real Estate Investments with Retirement Funds
Direct Investing
Retirement investors who want to invest directly in rental properties must have the knowledge to form the following plans:
- Finding the property
- Verifying that it is a good deal
- Financing the property
- Managing the property
“Those plans don’t have to be complicated,” says Davis. He recommends simplifying the process in the beginning and then increase the complexity once you gain more confidence and expertise.
“You don’t need to run ragged contacting every homeowner in foreclosure in your market,” says Davis. “You can start with properties listed on the MLS, or on Roofstock, or properties offered by local wholesalers or turnkey sellers.”
Indirect Investing
Retirement investors who do not feel equipped for the rigors of direct real estate investing can invest indirectly through REITs (real estate investment trusts), crowdfunding websites, private notes or through a silent partnership such as Seller Financing.
“There’s less of a learning curve with these indirect investments, and often more liquidity, so it feels less daunting for new investors to get started,” Davis says.
When indirectly investing, the level of real estate background knowledge required depends on the type of indirect investment you choose. For example, investing in a REIT vs. going through a crowdfunding platform has different degrees of expertise.
“When you invest in a REIT, it helps to have some knowledge of how to analyze ETFs or mutual funds, but it’s not required,” says Davis. “Likewise, it takes no knowledge to invest in a crowdfunding website’s private REIT.”
What is Seller Financing?
As defined by Investopedia, seller financing is a real estate agreement in which the seller handles the mortgage process, instead of a financial institution. Instead of going to a bank to apply for a mortgage and all that entails, a buyer can come to the seller directly. The two parties come to an agreement on all of the particulars, including sale price, down payment, possible balloon payments and terms of the sale. This is a great option for buyer’s who otherwise might not qualify for a bank loan. It’s great for the seller, since fees are kept to a minimum and the process can be completed quickly. No one wants long delays when making an investment!
Of course, seller financing comes with drawbacks as well. The worst of which is finding the right buyer, who will make timely payments. Legal fees could kill your profits if you need to take a buyer to court for nonpayment. It might be best for both sides to have an attorney present at the time of sale. On the buyer’s side, the big drawback are the interest rates. Since banks are competitive with those rates, you’re likely to find a better rate there. However, if you can’t receive the financing by conventional means, the point is moot. Both sides should be aware of both the benefits and risks with seller financing.
Real Estate Investing: Work with IRA Financial
Of course, we here at IRA Financial believe we’re the best Self-Directed IRA providers around. Our professionals are knowledgeable in all facets of the process. We ensure you remain IRS-compliant and all necessary documents are completed. Further, we’re there for you whenever you need us. Plus, there are never any transaction or account balance fees! Know you are in good hands when you work with IRA Financial.
If you would like to speak with one of our experts about seller financing, please contact us @ 800.472.0646. Also, be sure to check out our YouTube page for tons of interesting videos and podcasts about all things self-directed!
