Using Your Retirement Account to Invest in Real Estate            

One of the most common barriers preventing physicians from investing in real estate is the perceived lack of money.  But many probably don’t know that they can use the money in their retirement accounts to invest in real estate. 

Wait, what?!  Yes really, you can use the money that’s collecting dust in your IRA or old 401k account.  You might be thinking that there are a thousand rules to follow with retirement accounts, and that you can’t touch them without paying hefty penalties and fees. 

But here’s the truth: the process of using those retirement funds to invest in real estate is fairly easy and straightforward.  It’s done through something called a self-directed IRA (SDIRA).  

In this article, we’ll go over what a self-directed IRA is, how to use a SDIRA to invest in real estate, and special considerations to take into account when using an SDIRA.

WHAT IS A SELF-DIRECTED IRA?

In a conventional retirement account, you can only invest in publicly traded investment vehicles such as stocks, bonds and mutual funds.  These retirement accounts do not allow you to invest in alternative assets like real estate.

With a self-directed IRA (SDIRA), you have more control and flexibility because you can direct how to invest those funds.  An SDIRA allows the account owner to invest in alternative investments, such as real estate, private businesses, foreign currency, precious metals, crypto and much more.  This is the primary difference between a traditional IRA and self-directed IRA.

HOW TO USE A SELF-DIRECTED IRA TO INVEST IN REAL ESTATE

If you’re interested in using your retirement account to invest in real estate, below are 3 basic steps to follow:

Step #1: Find a custodian to open a self-directed retirement account

To use your retirement account to invest in real estate, you need to open a SDIRA.  And in order to open a SDIRA, you need to hire someone to act as the custodian of the account.  

Why do you need a custodian?  Think of the IRA custodian as the trustee of the account, while you act as the director.  You direct how to invest the account funds. The custodian manages the transaction and paperwork, makes sure you don’t violate any terms, and provides necessary financial reporting for the investment.

There are many custodians out there, and a Google search or a referral can point you in the right direction.  Pay attention to the associated fees (both upfront fees and ongoing annual fees), and also the types of investments you can make. Certain firms specialize in a particular asset class, so make sure you identify a custodian that allows and has experience with real estate.

Step #2:  Fund your Self-Directed IRA

Once you’ve opened an account, the next step is to fund the account either by doing a rollover or making a direct contribution.  If you’re making an initial contribution, you are capped at the annual contributions limits, meaning it could you years to build up enough capital to make a real estate investment. 

Alternatively, you can transfer (between the same type of retirement account) or rollover (between different types of retirement accounts) funds to an SDIRA.  The process of moving funds can take anywhere from a few days to a few weeks. Once your funds are in the SDIRA account, you can now choose what you want to invest in.

Step #3: Execute on Investments

Once you have opened and funded your SDIRA, you can start making investments.  When you find an investment you want to invest in, you instruct your custodian to invest your funds in the investment.

Following your investment, all expenses must be paid from the SDIRA and all income must go directly into the account.  Remember that you and your SDIRA are two separate legal entities.  You are not the owner; rather the IRA owns the real estate investment.  The title for the investment will read something like, “XXX Trust Company FBO (for the benefit of) [Your Name] IRA.”

SPECIAL CONSIDERATIONS FOR SELF-DIRECTED IRAs

One of main advantages of an SDIRA is the option to invest in alternative assets like real estate.  This allows for an opportunity to create a more diversified portfolio, beyond traditional stocks and bonds.  Another benefit of an SDIRA is the tax advantages and tax efficiencies, allowing you to defer income tax until you reach retirement age. 

However, there are several unique considerations related to SDIRAs which need to be taken into account:

• Unrelated business income tax (UBIT): If debt is used to finance a real estate investment with an SDIRA, you will face a tax bill for the debt-financed part of the income, also known as the unrelated debt-financed income (UDFI). For example, say you use $100,000 from your SDIRA to purchase a $400,000 rental property, taking out a mortgage of $300,000.  In this situation, 75% of the rental income would be subject to taxes as UDFI.  Depreciation can largely negate the tax implications of UDFI, but it’s still important to recognize this.
• Required Minimum Distributions: Just like a traditional retirement account requires investors of a certain age to begin taking required minimum distributions (RMDs) from their accounts, the same goes for an SDIRA. It’s relatively easy to meet this requirement with a traditional IRA because stocks, bonds, and mutual funds can be easily sold.  But because real estate investments are less liquid, you need to plan accordingly to ensure there is enough liquidity in the account to make the RMDs when the time comes.

FINAL THOUGHTS

SDIRAs offers a great strategy to invest in real estate in a tax-advantaged account.   If you’re interested in learning more about how to invest in real estate syndications, whether with your personal funds or through a self-directed IRA, get in touch with us and join our Clear Vision Investor Club to learn more about our current or upcoming opportunities.

Also check out this video interview below with Scott Maurer from AdvantaIRA to learn more about using a self-directed IRA to invest in real estate.