A Self-Directed IRA offers a distinct opportunity to utilize real estate for your retirement funds in a self-empowering manner. With a Self-Directed IRA, you have the ability to purchase diverse types of properties such as residential homes, vacation properties, as well as various others including commercial buildings, fix-and-flips, and undeveloped land.
After purchasing property, it is crucial that you familiarize yourself with the proper procedures for paying and handling associated expenses. The significant ones include property taxes, utilities, and maintenance. However, even minor purchases like cleaning supplies need to be made in the correct manner to avoid possible penalties. Here is the essential information you should be aware of:
What Is a Self-Directed IRA for Real Estate?
A lot of Americans commonly link IRAs with the stock market, assuming they are volatile and can result in loss. Nevertheless, what many individuals are unaware of is that they also have the choice of a self-directed IRA (SDIRA).
With a self-directed IRA, you can receive the same tax advantages as a traditional IRA while having greater freedom to choose how your IRA funds are invested.
In this article, we will specifically discuss the self-directed IRA and its application to real estate investments. There are various investment options available for a regular IRA, including commercial real estate, real estate options, promissory notes, tax lien certificates, limited partnerships, LLCs, Sub-C corporations, and certain types of precious metals.
Self-Directed IRA Expenses: How Much Does a Self-Directed IRA Cost?
Before discussing real estate expenses, it is important to remember that there are also a number of expenses associated with opening and managing a Self-Directed IRA account. The fees for Self-Directed IRAs can differ depending on the custodian. In this guide, we provide information on what to expect when it comes to fees and offer a convenient cost comparison calculator. At Madison Trust, we strive to keep our fees affordable and simple so that anyone can easily open a Self-Directed IRA without feeling burdened.
Paying Real Estate Expenses with a Self-Directed IRA
In a Self-Directed IRA, a designated custodian like Madison Trust is involved in all processes. When purchasing a property, the custodian will be registered as both the buyer and owner. The custodian will also handle the task of wiring the earnest money deposit (EMD). As a result, your IRA becomes the property owner instead of yourself. Subsequently, any real estate expenses should be paid from your IRA and all transactions must be carried out by the custodian.
To handle any real estate expense through your account, all you need to do is send us the invoice and a completed Expense Payment Request form at Madison Trust. We will take care of the rest.
Paying Real Estate Expenses with a Checkbook IRA
The Checkbook IRA, also known as checkbook control, is a popular option for both new and experienced real estate investors who have a Self-Directed IRA. This allows the account holder to bypass their custodian for transactions once the account is set up correctly. Instead, they can write checks and send wire transfers from a checking account linked to their IRA LLC or IRA Trust. Discover how a Checkbook IRA operates and why it is frequently chosen for investment purposes such as rental properties or house flipping.
What About Hiring a Property Management Company?
Is it possible to hire a property management company to handle the day-to-day maintenance at the properties owned by your Self-Directed IRA? Certainly! This option can be advantageous as it enables you to grow your rental portfolio without the additional responsibility of personally tending to your properties, interacting with tenants, etc. When opting for this approach, the property manager will be responsible for rent collection, expense payments, and transmitting any earnings to your IRA custodian for deposit into your IRA.
Two Things Never to Do
If you have either a classic Self-Directed IRA or a Checkbook IRA, there are two basic guidelines that can assist in maintaining a good standing with the IRS for your account and investments.
1. Always avoid using personal funds to cover real estate expenses.
You should never use your personal bank account to pay for any expense, even a small one, as it may lead to a prohibited transaction.
Under no circumstances should you employ an ineligible individual to carry out work on your premises.
In a Self-Directed IRA real estate investment, the account holder is considered the primary disqualified person but not the sole disqualified person.
- You (IRA holder)
- Your parents
- Grandparents
- Children
- Spouse
- Children-in-law
- Grandchildren
If your daughter has a property management company, you should refrain from hiring her as a consultant or her company as a property manager for real estate in your Self-Directed IRA. Similarly, even a seemingly harmless act of paying your son-in-law $50 to mow the lawn on the weekend is prohibited by the IRS.
7 Self-Directed IRA Real Estate Rules
There exists a total of seven primary rules for a self-directed IRA.
1. Property can’t be owned by you.
You cannot use your SDIRA funds to buy a property that you already own or that is owned by a “disqualified person.”
2. You can’t have indirect benefits.
You are not permitted to indirectly benefit from a property owned by your SDIRA, meaning you cannot personally rent any portion of the property because this would essentially entail paying rent to yourself.
3. Property must be uniquely titled.
You must have unique titles for SDIRA investment properties as you and your SDIRA are treated as separate entities. The title of all investment properties must accurately reflect the name of the custodian of your SDIRA for your advantage.
4. Property can be purchased with an SDIRA in combination with other funds.
It is possible to pool your SDIRA funds with other funds to buy real estate. Additionally, partnerships and undivided interest can also be utilized for this purpose.
5. Expenses must be paid out of the SDIRA.
All costs associated with owning a SDIRA investment property, including utility bills, maintenance fees, renovations, property taxes, building association fees, and similar expenses, must be covered by the SDIRA.
6. Generated rental income must be paid to your SDIRA.
All income generated by property owned by your SDIRA must be directly paid to your IRA, including income from rental property, revenue from sales, and other similar sources.
Pros and Cons of Self-Directed IRA Real Estate
There are three primary advantages to utilizing an SDIRA for investing in real estate.
- it offers increased return on investment (ROI) potential,
- the ability to exercise much greater control over your financial future, and
- it can help you protect yourself against fluctuations of the economy.
By having an SDIRA, you have the option to select from a wider array of potential investments and a larger range of risk – and typically, higher risk is associated with higher ROI. In a regular IRA, the primary strategy is diversification, aiming to shield oneself from stock market fluctuations. However, through an SDIRA, you can expand diversification further by investing in alternative assets beyond the stock market.
When contemplating investing in real estate with an SDIRA, it is important to be aware of several risks or disadvantages.
In order to ensure that your investment is a good one, it is essential to always perform due diligence on a property before considering its purchase. Assistance from a reliable real estate agent can play a vital role in accomplishing this.
Secondly, it is regrettable that there is always a possibility of experiencing fraud. In order to prevent being deceived by a deceptive plan, it is important to confirm the accuracy of your SDIRA details on every statement, decline any unsolicited investment proposals, inquire and steer clear of individuals who evade answering questions, remain cautious of ‘guaranteed returns,’ and seek assistance from a professional if uncertainties arise.
When it comes to real estate investments, it is important to apply the same thinking process as with stock investments, ensuring the diversification of your portfolio to minimize risk.
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