How To Invest
7 min read

Using Your Retirement Funds To Invest in Real Estate

Published on
June 13, 2023
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Whether you have built a sizable nest egg in an IRA or 401K or have only saved a small portion of your hard-earned money, one thing is certain, you don’t want to lose it all in the volatile stock market. You might want some of your savings tied to something more tangible like real estate, that can produce solid returns and even passive monthly income.

A self-directed Individual Retirement Account (SDIRA) is an individual retirement account (IRA) that allows for investments outside of the traditional financial markets. These alternative investments can be in real estate, franchises, precious metals, crypto currency, private equity and much more. A SDIRA provides the same tax advantages as a regular IRA and can also be set up as either Traditional or Roth. However, it is important to know that there are many rules and regulations that investors and account owners must follow in order to receive all of the potential benefits. Please keep in mind that Bluefox Ventures does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for tax, legal or accounting advice. You should consult your own tax, legal and financial advisors before engaging in any transaction.

First, let’s start with a few of the benefits:

1)   Increased ROI potential

With the freedom that you have to invest in alternative assets as well as the numerous tax benefits of a retirement account, you can increase your potential for a higher ROI. Imagine that through your Traditional SDIRA you purchase a home for $100,000 and sell it for $150,000 ten years later. Throughout the holding period, you rent it annually to a tenant for $20,000. Your rental income and sales proceeds would go back into the IRA and be tax deferred. It is tax deferred because it is in a Traditional SDIRA. In a Traditional SDIRA, you will eventually have to pay taxes on the tax-deferred income in your IRA when you take cash out. Now imagine if you had this property in your Roth SDIRA. Since you actually pay your taxes before placing those funds in the Roth account, all of the rental income and sales profits made are tax free.

2)   The ability to take control of your financial future

The freedom that you have to invest in alternative assets means that you will have an increased level of flexibility regarding the amount of risk that you want to incur. You can now make the right financial decisions for your retirement needs and goals.

3)   Protect yourself against economic fluctuations

The stock market can be volatile which is why diversification is key to protecting your wealth. The ability to invest in alternative assets, such as real estate, can help you create a healthy level of diversification, while simultaneously capitalizing on investment opportunities.

Now, all of that sounds great. However, before you move ahead, you have to understand some important SDIRA rules that must be followed. If you use the SDIRA to invest passively into a real estate syndication, which pools investor capital to purchase assets, it is more of a simple transaction.

On the other hand, if you use the SDIRA to actively acquire and manage your own real estate investments, then you need to be very careful. If you don’t follow all of the associated rules and regulations, you will disqualify the SDIRA and create a taxable event.

1)   Your SDIRA is not allowed to purchase property that is owned by you or a “disqualified person.” IRS regulations don’t allow transactions that are considered “self-dealing.” See this IRS page for more on prohibited transactions.

2)   You cannot have indirect benefits from property that is owned by your self-directed IRA. Examples of “indirect benefits” include purchasing a vacation home for you to occasionally use or renting office space for yourself in a building that your self-directed IRA owns.

3)   IRA investments must be uniquely titled. You and your SDIRA are considered to be two separate entities; and as such, investments should be titled in the name of your IRA.

4)   A SDIRA can buy real estate in combination with other funds. You can partner with other IRAs or you can also finance an investment with your IRA, but it must be structured properly.

5)   Investments that use financing are required to pay Unrelated Business Income Tax (UBIT). For SDIRA passive investors in a real estate syndication, the use of debt-financing in the deal will generate Unrelated Debt-Financed Income (UDFI) and result in a UBIT tax liability. However, the impact of this taxation in terms of actual dollars and percentage of income is typically nominal. The presence of this taxable income will require that you work with your CPA to perform the necessary tax filings.

6)   Any expenses that are related to IRA-owned properties must be paid from the IRA. These expenses would include all operating expenses like home association fees, utility bills, maintenance fees, renovations, and property taxes.

7)   Any and all income that is generated by property owned within your SDIRA is required to be paid directly into your IRA.

So how do you get started with a SDIRA? If you are ready to move forward, here is the process:

1)   Find a SDIRA custodian. A SDIRA custodian, also called trustee, is a financial institution that holds an account's investments for safekeeping and sees to it that all IRS and government regulations are adhered to at all times. Only custodians are authorized by the IRS to hold your IRA account assets. Fees and customer service are key decision factors in who you choose as custodian for your SDIRA. There are many out there, like ForgeTrust, Equity Trust, Quest Trust Company and NuView Trust just to name a few, and you should do your research to find the one that best fits your needs.

2)   Fund your SDIRA. There are multiple ways you can fund your account.

- Transfer from a Roth or Traditional IRA to your new SDIRA custodian. You can choose to transfer a portion of your funds or all of it.

- Rollover from an employer sponsored plan such as 401(k), 403(b), 457 or TSP after you leave the company. You typically can’t do the rollover if you are still working there, unless you are over the age of 59 1/2. At this age, you may be able to do an in-service rollover. You have to confirm with the plan administrator.

- Annual contribution into your SDIRA. As of 2022, the annual contribution limit is $6,000 for those under 50. If you're age 50 or above, you can contribute up to $7,000.

3)   Once your account is funded, you are ready to invest. To invest, you have to give instructions to your account custodian. This typically requires filing paperwork or communicating electronically. The length of time this will take and the amount of processing fees will vary by custodian. For this reason, many who plan to actively invest establish a limited liability company (LLC) or other entity to hold the SDIRA investment assets. The custodian would then deposit funds into your LLC’s checking account and you establish checkbook control. Transactions become as simple as writing a check, rather than having to contact your account custodian to direct your IRA funds.

Here is what you should bear in mind when considering holding your SDIRA assets in an LLC:

- It is the IRA, not you, who should be listed as the LLC member.

- You need an operating agreement document tailored for your SDIRA. You cannot use the standard operating agreement that most attorneys use for their standard LLC products.

- You must send a copy of the managing operating agreement to your SDIRA custodian

- You must maintain a strict separation between your own personal finances and those of the IRA.

- You cannot act as a personal guarantor or offer any assets outside of the IRA as collateral for any loans taken out by the LLC within a SDIRA.

LLCs in SDIRAs can be invaluable in establishing limited liability; thus helping wall off other assets in the IRA from being seized by creditors with claims against the property or asset within the LLC.

Let’s connect to see how Bluefox Ventures can help you diversify your portfolio by investing in alternative assets like real estate.

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