SELF-DIRECTED IRA INVESTING
At The PIP Group, we often work with real estate investors who want to use the capital in their individual retirement accounts (IRAs) to invest in fix-and-flip or tax lien investment deals. Most of them have an idea that they can do this, but very few understand how to make the process happen. Unfortunately, because most IRA companies do not necessarily benefit from real estate deals the same way they benefit from managing a stock portfolio, it can be difficult for real estate investors to gain access to their retirement funds. A clear understanding of what a self-directed IRA (SDIRA) is and how it may be used is the first step to gaining control of your retirement capital for real estate.
What is a Self-Directed IRA?
Technically, a self-directed IRA (SDIRA) is the same as a traditional individual retirement account because it offers the same tax savings that any other IRA offers.
Most IRA companies limit their IRA account holders to a few assets that benefit the IRA company or financial advisor, such as stocks, bonds, or mutual funds. However, with the self-directed version, the account holder may invest in a wide variety of assets, often referred to as “alternative” or even “exotic” investments, instead of the usual, run-of-the-mill assets like stocks, bonds, and mutual funds.
Self-directed IRA holders, often called self-directed investors, can invest in promissory notes, cryptocurrencies, private equity, and – you guessed it – real estate, in addition to almost anything else, with a very few exceptions.
What You Can Invest In
What You Can NOT Invest In
IRS rules prevent using SDIRA funds to invest in many types of collectibles, life insurance, S-corporation stock and certain other transactions.
The IRS offers a more complete list of prohibited assets on its website; click here to view their article.
3 Tax Benefits of Self-Directed IRAs
1. You get tax-deductible contributions.
The whole reason the IRS created the individual retirement account (IRA) was so that people would start saving for their own retirements instead of relying on pensions or social security. The federal government figured the only way to really get people to save was to offer some pretty serious incentives, so they decided to make contributions to IRAs tax-deductible and, to a degree, the returns generated in your IRA are tax-advantaged as well. However, most IRA companies did not want to work with IRA owners who were investing in things that the companies did not specialize in or understand, so soon there were very few companies (or investors) able to self-direct their IRAs. That led to the SDIRA, which is really the same thing as an IRA but held by a company that lets you decide where to put your capital rather than telling you it has to be in stocks or other “conventional” assets.
2. You can defer and sometimes eliminate taxes on the returns in your account.
This tax benefit is one of the big reasons real estate investors like SDIRAs. As you probably know, one real estate deal can change your entire bottom line for the better, but there can be a lot of taxes that pile up on those deals – especially once you learn how to do them over and over and over. Deals done inside your SDIRA however, could have deferred taxes (if you pay income tax on the distributions during retirement) or even no taxes if you have the right kind of account.
3. Non-financed rental income may not owe capital gains in full.Depending on how your account is structured, you may not have to pay capital gains when you sell long-term rental assets if you did not finance those assets when you made the purchase. If you did finance, you could owe partial gains, depending on the property, the financing, and the structure of your account.
How to Set Up a Self-Directed IRA
Are you ready to take control of your retirement capital and stop letting other “financial professionals” tell you how to invest your hard-earned retirement savings? If so, then you are ready to set up a self-directed individual retirement account (SDIRA). In the best-case scenario, it’s as easy as calling up your IRA custodian and discovering that you already have an SDIRA because your account is with a self-directed IRA company, but the odds of that are very slim. You will probably have to do a little work to get to your goal of a truly self-directed IRA.
Here are the steps you will need to take:
1. Figure out what self-directed IRA company is right for you.
Although there are a lot of SDIRA companies out there, not all are right for real estate investors. For example, the ones that take 90 or even 180 days to respond to direction will probably not fit your needs. Also, some SDIRA companies allow their clients to invest in alternative assets but not in real estate. If you get a “gold IRA,” for example, you still could be blocked by your SDIRA company from investing in rental properties or property tax liens. So talk to a few SDIRA companies and make sure you select one that will fit your needs.
2. Contact an SDIRA attorney.
You need good professional advice at this point. You will need to decide whether you want to go with a traditional SDIRA or a Roth SDIRA, just for starters. You may also need help getting your current IRA custodian to work with your future SDIRA custodian. This can be time-consuming, but do not give up! It will pay off in the short- and long-term.
3. Make the move.
Tell your current IRA custodian that you will be moving your account to your new SDIRA custodian. Your new custodian should be able to handle most, if not all, of the work from there. They will tell your old custodian what they need and how to handle the move. Then, you are ready to start self-directing your retirement!There are a lot of real estate investing firms that leave out that second step, and that is okay. If you are familiar with this space or if you already know the custodian that you like for holding your self-directed retirement account, you might not feel as if you need to consult an attorney. At PIP Group, however, we like to leave it in there because there are a lot of times that just 10 minutes with a knowledgeable expert could save you lots and lots of tax dollars down the road. We would never want you to miss that chance! After all, the more tax benefits you gain, the better positioned you are to keep right on investing in real estate with us.
3 Things to Know About Flipping in Your Self-Directed IRA
Real estate investors love using their self-directed retirement accounts to do great real estate deals. Flips are a particularly popular option for two reasons:
- They can create large returns relatively quickly, thereby increasing your working capital in your account; and
- They are one of the most easily understood types of real estate transactions.
While you can do flips in your SDIRA, there are a few complicating factors that many self-directed investors do not realize affect fix-and-flip deals done in their SDIRAs. Make sure you have all the facts before using your retirement funds to flip properties.
1. The IRS considers flipping houses to be an active business.
Many real estate investors read the sentence above and assume this means the IRS does not “like” fix-and-flip deals. However, the reality is that the IRS simply requires that you pay taxes on active business income generated in your self-directed account. The thinking is that you are actively generating income using a tax-advantaged account, and the IRS wants a “piece” of that pie.
While some IRA companies will tell you that you can “flip tax-free” in your self-directed retirement account, you should talk to your tax advisor before accepting this information as truth. In most cases, the IRS will require some payment if you flip regularly in your SDIRA. However, this can still be a great way to generate larger amounts of working capital in your account than you can simply by making annual contributions.
2. You may need checkbook control to do your own SDIRA flips.
If you want to flip a house, you know that there are a lot of things you will have to pay for directly and in real time. For example, when the contractor calls and needs to make a draw, you will need to be able to provide the funds for him to keep on working rather than waiting 30, 60, or 90 days for your self-directed IRA custodian to send a check. Most self-directed investors who handle their own SDIRA flips use something called “checkbook control” via a checkbook IRA LLC structure in order to gain direct access to their IRA funds. While this is a great tool, it does open you up to some risks if you do not have a good grasp of what is permissible in your SDIRA.
3. Flipping comes in more than one format.
Did you know that you do not personally have to handle a fix-and-flip deal to participate in the returns associated with successful flipping? You probably knew you could hire a project manager, but many self-directed investors also opt to participate in funds that flip instead of trying to manage a flip on their own. This helps create a greater degree of distance between you, the self-directed investor, and your SDIRA projects (good for helping you avoid prohibited transactions) while giving you peace of mind that your flip is being managed by an experienced manager with an on-site presence. This may not eliminate the need to pay some taxes on the returns from the flip, so consult your tax professional to be sure about your unique situation.
Frequently Asked Questions About SDIRAs
A self-directed IRA has the same rules, regulations and tax advantages as a traditional IRA, but it affords you far more flexibility in investing. You are able to diversify into any number of profitable assets, such as real estate. The bottom line is that YOU determine what you are investing in, and how much.
Although an SDIRA technically has the same rules, regulations, and tax advantages offered by any other IRA, not all IRA companies will permit you to self-direct your retirement funds. For this reason, you will probably have to move your IRA to a new company in order to begin self-directing your retirement investing. This can take a little time and may even involve paying a few fees, but the up-front costs will be well worth it when you are able to invest in assets like real estate that tend to come with returns that compare highly favorably to more volatile assets like stocks.
By law, any IRA must be officially held by an approved Custodian, which may be directly regulated by the IRS or affiliated with a bank or trust company. The Custodian does not make decisions for you on where or how to invest your SDIRA funds, but simply takes direction from you, the owner of the self-directed IRA, and executes investments on your behalf. The Custodian may reject your requests if they are deemed illegal or administratively unfeasible. Do you due diligence in researching the assets that a Custodian handles to make sure that includes the asset you are interested in investing in. Not all Custodians deal with real estate, for example.
There are certain types of asset classes in which self-directed investors may NOT invest, including collectibles like art or coins (with some exceptions, life insurance, stock in an S-Corp and certain other transactions . You also cannot invest in alcohol, rugs, or antiques, nor may you invest in property that you will be using personally, such as a vacation home.
The IRS defines collectibles as items including works of art, antiques, gemstones, metals, coins, stamps, alcoholic beverages, and “certain other tangible property.”
If you use SDIRA funds to purchase any prohibited asset, then the funds you used will be considered by the IRS to be “distributed,” meaning you will be taxed on them immediately, and any gains you created by investing in the collectible in question will also be taxed. The taxes could be as high as 28 percent before you tack on interest, fees, and penalties, so it is very important to understand this rule.
At The PIP Group, we are fortunate to be investing in one of the most conventional, straightforward, and accessible types of “alternative assets” out there: real estate. While there are a few things you could do to make your real estate a prohibited asset, such as living in the property after using your SDIRA to invest in it, this type of mistake is almost always wholly unavailable to our investors because we manage the projects and investments for you using our fully transparent investor interface to keep you informed.
CamaPlan is an administrator of self-directed IRAs for investors who want to take their retirement money off of Wall Street and into alternative investments they understand and can control. CamaPlan is built on a foundation that strives to provide clients with elite customer service and educational resources. They also boast a flexible fee structure and the fastest processing times in the industry.