10 Pros And Cons Of Self Directed IRA – Real Estate

10 pros and cons of self directed ira real estate investing

Recently I was having lunch with a friend that was interested in learning more about some of the passive real estate deals I’ve invested in. He specifically wanted to know more about multifamily apartment syndication.

When I started to explain to him that most of the deals I’ve done are for accredited investors only, he naturally wanted to know the minimum investment needed to get started.

Most of these deals require a minimum of $50K to get started with. For him, that wasn’t a problem except that some of his money was tied up in IRAs from previous companies he had worked for.

Interestingly enough, that same week I had stumbled on something that could potentially help both of us, the Self Directed IRA.

To be honest with you, I’ve become a bit bored as of lately. You see, once we became debt free several years ago, my wife and I were on Cloud 9. It was so nice seeing all of that extra money left over each month that used to go towards debt that now flowing straight into our pockets.

As with most things in our life, we became accustomed to that type of living. It eventually got to the point that it was not as exciting as it used to be (such as being on the hedonic treadmill). And that’s when the boredom crept in.

Now don’t get me wrong, I love investing in index funds and up until about three years ago, 95% of our investments were in them. This new boredom pushed me to become interested in other avenues of investing and that’s when I began searching for higher returns.

As a matter of fact, I stumbled upon another debt-free, “bored” person that called into the Dave Ramsey show:

It seems like I’m not the only disinterested person out there also looking for greener pastures.

During my search, I stumbled upon the self-directed IRA (SDIRA). Come to find out, it’s starting to change how people are investing their money, especially with real estate.

Before we get into the pros and cons of self directed ira real estate investing, let’s first look at exactly what a SDIRA is.

What Is a Self-Directed IRA?

According to Investopedia:

A self-directed individual retirement account (SDIRA) is an individual retirement account (IRA) in which the investor is in charge of making all the investment decisions.

The main difference between a SDIRA and a Roth or Traditional IRA is that the SDIRA provides the investor with greater opportunity for asset diversification outside of the traditional stocks, bonds, and mutual funds.

For example, funds in a SDIRA can be used for:

  • Real estate
  • Undeveloped or raw land
  • Promissory notes
  • Tax lien certificates
  • Gold, silver and other precious metals
  • Cryptocurrency (Bitcoin)
  • Water rights
  • Mineral rights, oil and gas
  • Livestock (yes, livestock)

The Custodian or Trustee

A self-directed IRA is not a plan you manage completely on your own. You’ll need a trustee custodian to administer the account. This would be a bank, or other entity approved by the Internal Revenue Service, not an individual. They’re responsible for record keeping and IRS reporting requirements.

Once this new account is set up, it has a new name and an account number. Once you select the property that you want the IRA to purchase, then the purchase contract, title, etc. are all in the name of the IRA.

Pros And Cons Of Self Directed IRAs For Real Estate

As you can tell from the list above, there are many ways a SDIRA can be utilized with regards to investing. Even though the list is long, the one area most considered is real estate investing.

As with most things, there are advantages and disadvantages you must be aware of. And before you jump right in, make sure you do your part to obtain as much knowledge to make an educated decision.

Here’s a list of the 10 pros and cons of self directed ira real estate investing:

1. Tax Benefits (Pro)

One of the main reasons investors use a SDIRA to purchase real estate is due to the tax benefits that it provides. Typically, whenever real estate is purchased, the gains received are taxed.

If real estate is purchased using a SDIRA, the taxes are delayed and your contributions can grow tax-deferred.

Even better, Roth SDIRAs contributions can be withdrawn tax-free upon retirement.

2. Must Do Your Due Diligence (Con)

As stated earlier, if you set up a SDIRA, you must have a custodian and their role is that of a “passive custodian.” This custodian will NOT perform due diligence on each transaction for you.

So it’s up to you to make sure that you do your own due diligence before making any investment. My rule of thumb is, “if I don’t understand it, I don’t invest in it.”

3. Can Invest In Alternative Investments (Pro)

One of the first questions people ask me when it comes to funding passive real estate investments is, “Jeff, Can I use money that’s in an existing retirement account?”

With traditional retirement accounts, you’re limited to investing in stocks, bonds and treasuries. But with a SDIRA, you have a much broader pool of assets to choose from.

Some of the options have been listed above but one of the main asset classes it’s now being used for is purchasing real estate.

Some people feel that by having alternative assets, it gives them a more secure retirement account because it allows them to grow their funds in multiple different ways.

4. Some tax breaks are lost (Con)

When using a SDIRA for purchasing real estate, you can’t claim depreciation on property held within it.

Also, there may not be a way to take advantage of operating losses as well.

5. Potentially greater returns (Pro)

When compared to typical investments such as traditional stocks, bonds, and mutual funds, real estate has the potential to produce greater returns.

And remember, those returns are tax-advantaged.

6. Unrelated business income tax [UBIT] (Con)

Another thing to consider is income. Most people consider income that is produced from their IRA as investment income. Occasionally, the IRS may categorize it as business income instead.

If it does, then that income can be subject to something called “Unrelated Business Income Tax” which can be taxed at rates as high as 39.6%.

7. Provide an extra layer of protection (Pro)

If you should ever fall on hard times and your finances are in jeopardy (bankruptcy), something that may give you a piece of mind is that your real estate investment will be safe in your SDIRA.

Why? Funds that are in SDIRAs are protected from creditors.

8. Lack of liquidity (Con)

As previously stated, the IRS requires the involvement of a certified IRA custodian to hold the account. Not only do these custodians have to approve the investments but they also must approve the releasing of the funds too.

Due to the amount of paperwork involved with tracking account transactions which are then reported to the IRS, this could potentially put a screeching halt to the turnaround time when you may need cash readily available.

9. Opening an LLC gives control (Pro)

One of the ways to help prevent the lack of liquidity is by opening a limited liability company (LLC) with your SDIRA.

By doing so, you’re able to gain what is called “checkbook” control. For instance, if you need quick access to your funds (if a new deal arises you have to act on quickly) then you can skip the middleman as the transactions aren’t waiting on administrators.

While you still need to report to your custodian, you only have to pay the fees for one meeting rather than several.

10. There is a lot of regulation (Con)

Your SDIRA could potentially become disqualified as a retirement account and subject to taxes and penalties if you handle any of the affairs with it incorrectly.

Any activity from buying, to financing, managing, or selling property with the IRA must be handled properly to avoid tax pitfalls.

Bottom Line

One of the top advantages of a self directed IRA is that it gives us a much larger range of investments than the typical stocks, bond and mutual funds than a traditional IRA allows for.

But remember, the custodian is in control and must abide by IRS guidelines in relation to filing paperwork and maintaining records.

Are You Interested In Using A Self-Directed IRA To Invest In Real Estate?

I personally work with a group called the IRA Club.

I’ve looked into several groups and have found them to not only be extremely knowledgeable but the least expensive.

Contact them to learn more about your options when it comes to using retirement accounts to invest in real estate.

Join the Passive Investors Circle