Real estate is one of the most popular alternative investments available. It can be a low-risk option that improves portfolio diversification and reduces volatility while providing reliable income and capital gains. The challenge is the high cost of entry. Whether individually or through syndication, real estate purchases often require a capital investment of $50,000 or more.
Fortunately, the IRS authorizes you to redirect tax-advantaged investments outside the stock market through a self-directed IRA without losing tax benefits. Self-directed IRAs allow you to purchase real estate using IRA, 401K, or other tax-advantaged funds for alternative investments.
Here is what you need to understand about self-directed IRAs:
Vetting the Investment
Self-directed IRAs require a custodian or trustee to oversee the transaction. The company buys and holds investments, per your instructions.
Custodians do not vet or approve the asset. Nor do they provide tax, legal, or investment advice or otherwise influence decisions. The trustee also does not assume liability for the quality or risks associated with your property.
You are responsible for vetting the opportunity, including understanding the risks and potential rewards before committing to a particular investment.
More Complex Ventures
While self-directed IRAs branch out from the traditional market investments, there are complexities involved with each venture. For example, you may choose to buy single-family homes, an apartment complex, or tax lien certificates.
With each option requiring a different level of expertise, the vetting process takes longer and is more in-depth than choosing a mutual fund, stock, or bond. Each opportunity also comes with varying sets of risks and rewards to consider.
Alternative investments tend to have longer hold periods. It is not usually possible to cash out an asset within a few days, like stocks or bonds.
Real estate is illiquid because you may not receive a return of your capital until the sale of the property. In some cases, you can access a portion of the gains through income the property generates. However, a change in market conditions could extend the hold period and impact access to your capital.
Not Following The IRS Rules Can Have Severe Consequences
All tax-advantaged funds have rules you must follow. Break the rules, and it could create a taxable event.
Like any IRA, you must qualify to make contributions, leave funds in the account until reaching 59 ½, meet the required minimum distributions (RMDs) starting at 70 ½ for traditional IRAs, etc.
In addition to these standard regulations, other actions could cause you to lose your tax-preferred status. These include participating in a transaction that is not permitted, doing business with a disallowed person, or choosing a forbidden investment.
Investing in Commercial Real Estate Syndications
One way to participate in commercial real estate without qualifying for multi-million dollar properties is through syndications using IRA dollars. To accomplish this, you must fund a self-directed IRA, opening the door to using tax-advantaged funds for real estate transactions.
To learn more about how to invest in commercial real estate syndications using IRA funds, watch our introductory video here.