Self-directed IRA and Commercial Real Estate Investments
Many accredited investors hold much of their investable net worth in IRA’s or other tax deferred accounts that have limited options for diversification. At the SmartCap Group, we often get the question from investors of if they can invest in one of our offerings through a self-directed IRA. The answer is yes, you can invest in SmartCap Group offerings through your self-directed IRA and there can be many benefits, especially when viewed from as long term investment.
What are Self-Directed IRA Allowable Investments?
Beyond a few small restrictions such as collectibles, life insurance contracts or stock of a S-Corporation, you can invest into a myriad of options according to IRS Code Sec. 401 IRC 408(a) (3):
The list of possibilities is very long. In no particular order, here are a few of the more popular options for Self Directed IRA investing.
- Real Estate (improved and unimproved)
- Secured & Unsecured Notes
- Tax Liens & Deeds
- Judgments & Structured Settlements
- Accounts Receivable Factoring
- Commercial Paper
- Equipment Leasing
- Precious Metals
- Private Company Stock
Pros of Utilizing a Self-Directed IRA for Real Estate Investments:
Long-term horizon. Real Estate investing is a long-term game, which works well with retirement accounts. Millennials and Generation X still have between 10 and 35 years to hold commercial real estate, allowing for appreciation and pay down of debt. At retirement, obtaining the highest cash income without reducing your principal equity investment is paramount to ensuring an extended retirement income stream.
Leverage. Commercial real estate provides rental income that covers debt payments producing leverage for you money otherwise unavailable in retirement accounts. This makes commercial real estate an outstanding long-term investment class, because as your tenants pay down the ﬁnancing for you, equity is built up in the asset. Once you no longer have debt payments, your cash return instantly increases, multiplying your cash ﬂow multiple times over. Owning real estate long term in your retirement account allows for the pay down of the debt when you don’t need the cash flow, and a magnified cash stream when you need it most… when you’ve retired!
Diversification. Real Estate Property acts as an excellent hedge against cyclical changes in other parts of the economy. For example, depending on the monetary headwinds, investors are often seen rotating en masse out of bonds and into stocks, or vice versa. Real estate has a lower volatility, and it provides a foundation to keep a strong retirement portfolio regardless of market fluxes.
Low volatility. Again, the value of real estate tends to fluctuate slowly compared to other assets. While a stock suffers or thrives on an unexpected earnings report, determining the long-term value of a particular property is a comparably predictable affair. Real estate prices in general are tied to large macroeconomic movements that push right on through seasonal trends.
Tax-deferment. The income earned through real estate is a big pull for many investors. Of course, that income is taxable. That’s not the case when the investments are held in a Roth IRA retirement account, however. The taxes on any income and gain in value are deferred until the distributions are withdrawn from the account.
The days where it made sense to rely solely on the usual stock-bond mix for retirement portfolios is now behind us. There are now virtually no practical barriers standing between accredited future retirees and the benefits of real estate opportunities.
How to Invest Through Your IRA:
There are numerous groups that exist that help you setup a self-directed IRA and invest in alternative asset classes. Each group utilizes a slightly different fee structure. Please review the sites for fee structures. Personally, I utilize The Entrust Group. A few sources are listed below. Searching for ‘Self Directed IRA Custodian’ will allow you to find a current list of qualified custodians.
**Note: Custodians must be approved by the IRS to be legal custodians of a self-directed IRA.
What You Should Avoid:
There are also a few rules that you need to know. We always recommend you talk with your accountant and ensure you are doing things correctly. A few of the basic rules:
Prohibited Transactions: A “prohibited transaction” is defined by the IRS code as a transaction that occurs between a retirement plan and a “disqualified person”. This results in the loss of the tax-deferred status or other penalties being assessed against the plan and it’s assets. As an example, the account holder (disqualified) could not buy real estate (improved or unimproved) for personal use.
Disqualified Investments: As a Self-Directed IRA or 401(k) account holder, you may not personally benefit from the investments made with your retirement plan. You, along with your spouse, children, grandchildren (and their spouses) parents, and grandparents are “disqualified”. Also, certain entities in which you own more than 50% interest… such as corporations, partnerships, and trusts are disqualified.
Asset/Allocation Limitations: In 1974, Congress passed the Employee Retirement Income Security Act (ERISA) making IRA, 401(k) and other retirement plans possible. Only two types of investments are excluded under ERISA and IRS Codes: Life Insurance Contracts and Collectibles (art, jewelry, etc.). Everything else is allowable including real estate, tax liens, notes, precious metals, stock of private companies, etc