Is Putting Real Estate in Your Self-Directed IRA a Realistic
Investment choice?
The pursuit for a secure retirement has become progressively
more difficult. Given the uncertainty of today's stock market in
light of corporate governance failure on a massive scale with
the Enron and WorldCom scandals, the poor recovery of investment
because of the panic selling of stocks and bonds that have since
wobbled their way back up, without bringing investors' funds
with them and the political and economic uncertainty generated
by the 'war against terrorism', it is not surprising that
investors are looking for alternative choices to invest their
retirement funds.
These days, many investors prefer to have a wider range of
choices and the ability to diversify their retirement fund
investments outside the poorly performing, so called
conservative choices of stocks and bonds, and into other areas.
This has resulted in a massive expansion in the market for
self-directed IRAs.
Oftentimes the phrase self-directed IRA is tossed around by
prominent investment firms and is only narrowly understood by
the majority IRA investors. Unbeknownst to many self directed
IRA investors many investment firms would have them believe that
the term self-directed IRA only refers to the ability to choose
which stocks, bonds and mutual funds they can buy. Fortunately,
there is more to this narrative.
In contrast, a growing culture of investors is educating
themselves on their investment alternatives and they are now
starting to invest in real estate and other non-traditional
assets. Indeed, any legitimate business investment is open to
them both as single investors and undertaking group investments.
If you know what you are doing or have expert advice in the
area, it is possible even with low cash reserves to diversify
retirement portfolios and in particular to capitalize on the
growing real estate industry for example.
Most conventional financial planners don't offer truly self directed IRA plans
since they may operate under plan documents which only allow
investors to invest in stocks, bonds and mutual funds. Nor is it
in their interest to do so. Their commission structures are set
up to favor investment in the financial markets whether this is
in the best interest of the investor or not. Which means their
advice is hardly objective.
Of course, this is not advising that investors completely
abandon stock market offerings, merely that they do not keep all
their eggs in one basket. Just as stock markets rise and fall so
can real estate prices. But diversifying your investments
minimizes the risk on your returns.
Procuring real estate for investment purposes with an IRA
provides several favorable tax breaks. A Roth IRA allows the
investor to benefit from tax deferral while it is growing and to
be free from tax on distribution in contrast to a traditional
IRA which is taxed at time of distribution. Nor is there a
minimum distribution and investors can also continue to pay into
Roth IRAs which can be of benefit if they intend to pass them to
their heirs (which can be done without taxation). In addition,
unlike 1031 exchanges, there are no specified investment
timeframes or requirements to procure 'like kind' investments.
Finally, capital gains tax is not applied since taxation does
not occur until distribution.
All of these factors contribute to making real estate investment
with IRA funds very tempting. However, it is not something that
should be undertaken lightly nor should investors, unless they
are experts in their own right in the tax and investment laws,
undertake for themselves, due to the strict and sometimes
complex legislation imposed through the IRS. Otherwise they may
find themselves exposed to penalties and taxes. Just as you
choose a traditional financial advisor when looking into stock
and mutual fund investments you should also look a properly
qualified self-directed IRA advisor.
First, traditional financial advisors are not usually best
placed to give advice on real estate investment. While they have
a good understanding of stocks and shares, they have very little
experience of the real estate market. Instead, you should look
for an advisor who can help you structure IRA and real estate
entities, evaluate investment opportunities and avoid infringing
self directed IRA rules in setting up investments.
Your IRA advisor will need to have extensive knowledge of
self-directed rules and the expertise to implement complex deals
plus a good strong background in real estate and real estate
development. Because, while an investment in a single property
is probably no more difficult than buying your own home, using
private funds, especially self-directed IRA funds to invest in
real estate developments, real estate lots, purchasing apartment
communities and other larger scale real estate investments is
something that most people don't have the requisite knowledge to
undertake.
A good example is rehabilitating individual residential real
estate. If you have never undertaken this kind of work, it can
be a very risky business. Without substantial amount of real
estate investment experience, you can easily lose your IRA
retirement money. It is very important to have an appropriate
real estate advisor who understands where to find to good real
estate opportunities and knows what a realistic real estate
investment and realistic rate of return is and how to
appropriately manage a real estate rehabilitation or real estate
development project from start to finish. Mainstream
do-it-yourself TV shows showing rehabilitation projects are a
case in point as the majority of people go over budget during
the rehabilitation and the majority of times lose money. Don't
let this happen to your retirement.
Ability to offer advice has to be accompanied by permissibility
to offer advice. A self directed IRA custodian (as opposed to a
self directed IRA advisor) may not offer any investment advice
to an investor. It is prohibited. They must maintain a neutral
position and can only give you advice on the IRS regulations and
their firm's investment policies. Therefore, an IRA custodian
cannot offer advice on real estate transactions, which is a good
thing because their primary purpose is to hold account holders
monies.
In short, real estate investment is a realistic option for most
investors looking to diversify their holdings, but the key to
benefiting from it is getting the right advice from the right
source.