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Over the past decade, due to the turbulence in the financial markets, an evolving method of real estate investment method has been making the news. In particular, the self-directed IRA allows you to save for retirement like a standard IRA account, but with an unique twist. This sort of IRA account can earn tax-deferred retirement income while being invested in rental properties and other alternative investments.

What is a Self-Directed IRA?

The self-directed IRA is similar to a standard IRA or Roth, but with some significant differences.

With a standard IRA or Roth, you can add funds to the account, but you are not necessarily required or able to make active investments on behalf of the plan. Also, when you do make investments, they are usually restricted to the types of securities you can invest in such as: stocks, bonds or mutual funds. Additionally, when you open the IRA, depending on the custodian you cannot administer the account yourself.

On the other hand with a self-directed IRA, you are allowed to actively make investments on behalf of the plan. In addition to the traditional securities, you can also invest in non-traded alternative assets like real estate, physical gold and other precious metals, oil and gas leases and more. However, do not think you can take this knowledge and take the John Wayne approach to investing your retirement. Although the self-directed IRA offers more investment options for your retirement dollars, it is not without considerations and restrictions of its own. For example, you are still required by law to hire a trustee to administer the account by filing the necessary forms with the IRS and other restrictions apply.

Self-Directed IRA Considerations and Restrictions

6 Concerns You Should Take into Consideration

As this type of investment become more popular, you will see more specialized companies popping up to meet the growing demand. Therefore, when you get started, the biggest consideration is to make sure you open an account with a trusted, respected IRA provider, who is knowledgeable with self directed investors and their needs. Not all of these custodial providers companies have the experience and skill they need to properly administer your IRA, so you should always do your homework beforehand. Run the company name through online business sources, like the Better Business Bureau, as well as news search engines, but be discerning as many sites, especially Yelp filter out good reviews in lieu of negative reviews. It is always best to speak to actual clients about their experiences with the company.

Another concern is that self-directed IRAs are time-intensive. The time it takes to open and fund the account, including transferring or rolling over assets and find an investment property, could be weeks and even months, so again make sure you are working with a reliable custodian.

Unlike standard IRA and Roth accounts you may be accustomed to, with a self directed IRA account, you are responsible for completing all of the research on the investment, and making sure it is a sound decision before committing your funds. This could include doing an analysis of the top real estate markets and knowing the art of structuring a real estate transaction and making a deal work for all parties involved.

Just as important as vetting your custodial partner, you need to vet the entity or the person you are going to do business. Just because someone you have never met comes to speak at your church offering a secret money code or investment opportunity, does not mean that you need to give them your life savings. If you are interested in learning how to better protect yourself and your hard earned IRA savings from fraudsters, go here.  

Another concern to be aware of is the custodian must release the funds to enable the transaction. If you make an offer on a property, before making sure the trustee is able to review your transaction and release the funds, you could lose the sale.

Although all rents, and other money collected on the property go into the IRA account, the account is also responsible for paying all expenses, taxes and fees associated with the property it purchases. For example, if you purchase and rent out a condo on a golf course, you need to make sure the rent you charge is enough to cover association dues, greens fees and any other expenses. Again, this goes back to understanding how to structure a transaction beforehand. Otherwise, you could end up depleting your IRA and thus lose money on your investment.

Restrictions Do Apply

Although you do have more investment options with a self-directed IRA, restrictions still apply. The list of prohibited investment transactions are listed in the IRS code, section 408.

These prohibited items include:
  • Life insurance;
  • Collectibles like rugs, artwork, stamps, metals and coins (except for certain types of bullion and coins minted by the U.S. Treasury);
  • Alcoholic beverages; and,
  • Personal property.

While you can use a self directed IRA to buy real estate, there are some additional guidelines that you need to be aware of. You are restricted from using the funds to pay off your personal mortgage, or to live in or use the property for a vacation even if you pay fair market rent back to the IRA itself.

There are some additional tax rules you need to aware of as well. Since an IRA is already a tax favorable, tax-deferred investment vehicle, you lose the typical depreciation tax deduction that you would normally receive on an investment or investment property.

In addition, to avoid conflicts of interest, you cannot involve your spouse, immediate family members or companies in which you have a 50-percent or greater interest. This could include renting out the investment property to family members, using the property as offices for a business you own, and purchasing properties from immediate family members. Neither, can you use your IRA as collateral to purchase another investment.

Ultimately, if you have the funds available, understand the art of deal making, can complete proper due diligence and know the IRA rules, a self-directed IRA could be a viable option for real-estate investment.