A self-directed IRA (SDIRA) is a type of individual retirement account (IRA) that allows investors to hold alternative investments not typically found in conventional IRAs. In addition to traditional assets like stocks, bonds, and mutual funds, SDIRAs can invest in real estate, precious metals, cryptocurrency, and more.SDIRAs are considered "self-directed" because the account holder directly manages the investments and assumes all risk, although a custodian or trustee administers the account. They come in two forms: traditional IRAs that take tax-deductible contributions, or Roth IRAs that allow tax-free distributions in retirement.
Benefits of Investing in Real Estate with Self-Directed IRAs
Diversification: Investing in real estate through an SDIRA can provide diversification benefits by gaining exposure to an asset class that is not tied to the stock market. This can help stabilize the portfolio and hedge against market volatility.
Tax Advantages: Real estate investments in an SDIRA benefit from tax-deferred growth of earnings. Rental income and capital gains generated by the property are not taxed until withdrawal in retirement.
Control: SDIRAs offer account holders more control over their investments compared to traditional IRAs. Investors can directly choose and manage real estate properties based on their expertise and market outlook.
Asset Protection: Real estate investments in an SDIRA provide multiple exit strategies, such as sale, refinance, or value-add improvements. This flexibility helps protect the investment in the event of a downturn and can provide ongoing cash flow even if property values decline.
Risks and Considerations
Complexity: Managing real estate investments within an SDIRA is more complex than investing in traditional assets. Investors must navigate intricate IRS rules and regulations, such as restrictions on benefiting from the property and funding repairs from the IRA.
Liquidity: Real estate is an illiquid asset, meaning it can be challenging to access funds quickly if needed. This lack of liquidity can be problematic for SDIRA owners when required minimum distributions come due at age 73.
Fees: SDIRA fees vary by custodian and type of investment and depend on actions taken by the account holder. These fees can be higher compared to traditional IRAs.
Fraud Risk: SDIRAs have a higher potential for fraud, as promoters sometimes misrepresent the legitimacy and value of underlying investments. It is crucial to independently verify information provided by custodians and promoters.
Rules and Regulations
To invest in real estate through an SDIRA, the account must comply with specific IRS rules and regulations:
The property must be owned by the IRA, not the account holder or any disqualified persons.
The IRA cannot use non-recourse financing to purchase the property.
The IRA cannot derive any personal benefit from the property, such as using it for personal use or renting it to disqualified persons.
All expenses related to the property, such as repairs, taxes, and insurance, must be paid from the IRA.
Violating these rules can result in severe consequences, including the IRS deeming the entire IRA taxable and imposing penalties. Seeking advice from financial and tax professionals is crucial to ensure compliance with SDIRA regulations.
Conclusion
Self-directed IRAs offer investors the opportunity to diversify their retirement portfolios with real estate investments while benefiting from tax advantages. However, this flexibility comes with increased complexity, risk, and regulatory requirements. Before investing in real estate through an SDIRA, it is essential to carefully consider the potential benefits and drawbacks and consult with financial and tax professionals to ensure compliance with IRS rules.
Disclaimer: This article is for informational purposes only and should not be considered financial advice. Please consult with a qualified financial professional before making any investment decisions. The content of the above article is based on references, learnings and interpretations. Invest Corners does not guarantee the accuracy of the information provided.
Sources:
Comments