Self-directed IRAs must comply with IRS rules when investing in alternative assets like real estate. Property must be properly titled, expenses and income divided as appropriate and tax returns filed accordingly.
If you purchase real estate using debt financing, its income will incur unrelated business income tax (UBIT). This could prove detrimental to the funds in your retirement account.
Taxes
Individual Retirement Arrangemenst (IRA), is a tax-advantaged investment account designed to help you save for retirement years tax efficiently. Self-employed and small business owners frequently utilize an IRA. You can select between traditional or SEP (Simplified Employee Pension) IRA to invest in stocks, mutual funds and ETFs.
An IRA asset typically incurs short-term capital gains taxes if its sales price exceeds its adjusted basis, however you may be able to avoid them if held for over one year.
An Individual Retirement Account, or IRA, allows most publicly traded investments and some alternative investments; however, certain types of assets like real estate or collectibles (artworks, rugs, antiques, coins and stamps) cannot be included. Speak to your custodian or broker for additional details on what can be held within an IRA and their respective rules regarding required minimum distributions after reaching a certain age threshold.
Distributions
Many traditional IRAs provide the option of taking distributions in-kind, where your IRA custodian transfers investment holdings directly from your IRA account to you at fair market value. The taxable value of in-kind distributions is calculated by multiplying your account balance times an age factor and applying this calculation directly; should it prove too complex, consult your custodian.
In-kind distributions offer many advantages when it comes to liquidating assets that would otherwise be difficult or impossible to sell for cash, such as real estate, precious metals and private equities. Unfortunately, however, their drawbacks also can include your basis being reset when taking an in-kind IRA distribution – for instance if shares bought at $20,000 were distributed in-kind but later sold at lower prices later on for $6,000 more, your tax reporting would become inaccurate.
Investments
Many IRA investors take advantage of the tax advantages afforded by retirement plans by using non-traditional assets like real estate and precious metals to invest in non-traditional assets like real estate and precious metals, often sold through specialized exchanges that work with self-directed IRA custodians and incur additional fees and costs for this process.
Investors must also carefully consider whether these alternative investments can make money. Real estate, for instance, doesn’t just appreciate; it also generates rental income. Although IRAs don’t lend out funds as loans do so some creative investors use them to flip properties by seller financing them to new buyers and using an IRA as “flipping” vehicle.
However, IRA owners must take extra precaution to prevent prohibited transactions, such as using their funds to benefit personally from real estate investments or provide services such as property management for profit, guarantee or pledge their IRA assets or invest in investments that benefit disqualified people. It’s essential to independently verify all information provided within their IRA account statements such as prices or asset values before acting upon it.
Liquidity
Liquid assets like stocks and mutual funds must be traded on established markets with easy transferability of ownership, making them more readily converted to cash than collectibles, real estate or gold coins.
Liquidity is key for many reasons, including meeting your required minimum distributions (RMDs) in retirement or taking advantage of investment opportunities that arise. Because IRAs cannot take RMDs until after age 70 1/2 has been reached, investors should ensure their accounts contain enough cash or liquid assets to cover this expense.
Liquidity is of utmost importance when investing in alternative assets. According to the Securities and Exchange Commission, self-directed IRA promoters frequently provide limited or inaccurate information on investments both financial and nonfinancial, or incorrect pricing and asset values; such activities violate prohibited transaction rules that forbid use or provision of services to an IRA by nonqualified persons.
