Self directed IRAs have become very hot among investors with the rise in popularity in alternative investments such as real estate, gold, and cryptocurrency. They allow retirement account owners to invest money in assets that your traditional IRA or 401k would not. Typically they have been restricted to Wall Street type products like stocks, bonds, and mutual funds.

Typically around this time of year, investors are looking at maximize their retirement account contributions before the April 15th tax filing deadline. Something really stupid I have seen people doing is buying real estate using their Self Directed IRA.

It’s stupid for a multitude of reasons, here’s why:

1.) Real estate is illiquid. Retirement accounts are illiquid (at least until you reach an age to start taking distributions.) Why would you want to double down on the biggest risk involved with real estate, liquidity risk? Besides, I am not even a fan of tax advantaged accounts like IRAs and 401ks because you cannot do what you want with your OWN money. I value being nimble and having options. This scenario is very restrictive.
2.) Lack of leveragability. One of the best parts of the real estate asset class is that it is a hard asset. Banks love hard assets as collateral and therefore allow you to leverage them. Which means you can buy and control a $100k for $20k essentially or whatever your bank will allow you to do. This allows you to scale multiples on your net worth over time. For example. Let’s say you buy a property for $100,000, all cash, no leverage. Let’s say that property appreciates 3%, pretty average for Rochester, NY in good locations. Let’s say you sell that property for $103,000. That $3000 return on investment yielded you 3% return on your money. Now, lets say you buy that same building and put bank financing on it. So you put $20,000 down and have your bank put a $80,000 mortgage on it. The property appreciates 3% or by $3,000. $3,000/$20,000 = 15% return on investment. Plus you can buy 5 properties using that same type of leverage; much better for building your long term wealth! With Self Directed IRAs (SIDRA), you cannot use bank financing in this way. Why not? Because most bank financing requires personal guarantees, something strictly prohibited by the IRS in Internal Revenue Code Section 4975, therefore precluding you from using leverage. There might be come convoluted ways in which to get around this but at the end of the day usually doesn’t make sense.
3.) Lack of tax benefits. Yes, SIDRAs and other tax advantaged retirement vehicles have tax advantages in their own right but it ends up stripping out one of the greatest part of owning investment real estate, depreciation! Depreciation is an expense that you take “on paper” each year you own a piece of investment property. When you own desirable real estate assets in great locations, you pay for it. You usually have a higher cost basis when you buy great property. You can take a certain portion of that basis as an expense each year. Often times that expense synthetically wipes out positive cash flow while you own the property. Assuming a dollar today is worth more than a dollar tomorrow (it’s a fact, look up “Time Value Of Money”), the less you pay in tax today, reinvest those tax savings, it’s quite simply explosive to building your net worth over time.

So now that I’ve thoroughly trashed buying real estate with your SIDRA, you should know some tactics on how to use your SIDRA to grow your real estate business. One tactic that is my favorite is making loans out of my SIDRA. Loans that are backed by real estate. You can make loans out of your SIDRA with interest rates and terms more attractive than typical private or hard money. Why would you do this? Relationship building. If you have a reciprocal relationship with another investor with a SIDRA, you can loan them money to help them grow their real estate business and they can lend you money to help you grow yours, without the crushingly brutal rates of some hard money lenders.
Another way to invest is by investing in an LLC or special purpose vehicle as a limited partner (silent partner) and partnering with the managing person of that LLC in exchange for an equity stake. The only caveat is to make sure that whatever bank financing that investor is using will allow your IRA to own membership interest in that deal without having to sign a personal guarantee. Usually you can avoid personal guarantees by having your IRAs membership interest at 19% or less in that LLC.

What are your thoughts on this? Do you invest in real estate with your SIDRA?…(read more)

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Investing in real estate is a popular way to build wealth and secure financial stability for the future. Many people choose to use their Self Directed IRA (Individual retirement account) to invest in real estate as a way to diversify their portfolio and potentially earn a higher return on their investment. However, there are several reasons why buying real estate with your Self Directed IRA may not be the best option for everyone. Here are three reasons to consider before making this decision:

1. Risk and Lack of Diversification:
Investing in real estate with your Self Directed IRA can carry a higher level of risk compared to other investment options. Real estate markets can be unpredictable, and property values can fluctuate significantly over time. If the value of the property decreases or if it becomes difficult to find tenants, your investment could suffer a loss. Additionally, investing a large portion of your retirement savings into a single asset class like real estate can lack diversification, leaving you vulnerable to market downturns.

2. Limited Liquidity:
Real estate is a relatively illiquid investment compared to other assets like stocks or bonds. If you need to access your funds quickly for an emergency or unexpected expense, it can be challenging to sell a property and convert it into cash in a timely manner. This lack of liquidity can be a significant drawback for individuals who may need to access their retirement savings in a pinch.

3. Complexity and Restrictions:
Investing in real estate with your Self Directed IRA can be complex and comes with various rules and regulations that must be followed to avoid penalties. For example, you may not be able to use the property for personal use, rent it to family members, or perform certain types of renovations without risking the tax-advantaged status of your IRA. Additionally, there are restrictions on how you can finance the purchase of real estate within your IRA, and any income generated from the property must be reinvested back into the IRA.

In conclusion, while investing in real estate with your Self Directed IRA can have its benefits, it’s essential to consider the potential risks and drawbacks before making this decision. If you’re not comfortable with the level of risk, lack of diversification, limited liquidity, and complexity associated with real estate investments, you may want to explore other investment options within your Self Directed IRA that align better with your financial goals and risk tolerance. Consulting with a financial advisor or tax professional can help you make an informed decision based on your individual circumstances and retirement objectives.