Real estate comes with a slew of inherent tax benefits, from landlord tax deductions to depreciation, from the lower capital gains tax rate to the many ways to reduce or avoid capital gains taxes.
But real estate investors can go even further, and invest in rental properties through their IRA.
Not your normal brokerage IRA however. If you want to buy real estate using your IRA, you need to set up a self-directed IRA with a custodian. Deni and Brian break down how to invest in rental properties with a self-directed IRA.
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Denise Supplee: Hello Everyone, and welcome to Spark Rental’s Facebook Live and podcast. Last week Brian was joined by Michael Quan of Financially Alert, and that was a really good interview. And we ask that you let us know where you’re joining us from and please feel free to ask your questions because we talk to each other enough. So, we would like to talk to you guys, today. Brian is going to talk to us mostly about how to invest in real estate with a self-directed IRA. You know and looking for creative ways to finance properties is becoming more and more needed. With that being said, Brian, why don’t you tell us a little bit about this.
Brian Davis: Sure. So, yeah, we had fun last week with Michael Quan from Finance Alert. He retired at thirty-six despite having several children, and he did use real estate as well. And he also took advantage of a lot of tax-deferred accounts, like IRAs. So real estate comes with a series of built-in tax advantages, things like a plethora of deductions and depreciation, the lower capital gains tax rate, rather than the normal income tax rate. There are plenty of ways that real estate investors can reduce or defer their capital gains taxes. But if real estate investors want to go even further, they can invest directly in rental properties through their IRA Well before we jump into how self-directed IRAs work, we’ll do a lightning overview of how regular IRA’s work. So, IRAs are not handled through your employer. These are directly owned and controlled by you as opposed to your employer. So, you don’t have to move money around. If you change jobs, you open these accounts directly through your normal investment brokerage account. So, like I use Charles Schwab, for example, but you can use TD Ameritrade or JP Morgan or whatever, you know, whoever you have your regular investment banking with, you can open either a traditional IRA or a Roth IRA. And the tax benefits are opposite for traditional and Roth IRAs, traditional IRAs you can deduct from your taxable income this year. Any money that you contribute to your IRA. Roth IRAs are the opposite. You don’t get an initial tax benefit, but the money grows and compounds tax-free. And when you withdraw it in retirement, it’s tax-free. Whereas with traditional IRAs, you have to pay income taxes on the money you pull out in retirement.
Denise Supplee: Is there a way that you can gauge which one of those is better for your individual needs?
Brian Davis: Yeah, it really depends on whether you think your income tax rate will be higher in retirement than it is today. So young people in their 20s and early 30s as well should really normally be investing through a Roth IRA, people who are at the peak of their earning years and maybe their 40s or 50s. It may make more sense to invest through a traditional IRA. But, you know, I am of the opinion that tax rates are actually going to go up in the US in the coming years, in the coming decades. So, I actually think that you’re better off with a Roth IRA regardless because I think, the way that the federal government is spending, they’re going to be ratcheting up tax rates. So, I almost feel like it’s inevitable. So, yeah, just a thought not to say I don’t want to get bogged down in that discussion. But right now, the contribution limits are pretty low for IRAs. Six thousand dollars per year in twenty twenty-one. If you are under 50 if you’re 50 and over, you can contribute a little bit more. You can contribute seven thousand dollars per year. So, we’re not talking about a massive amount of money here each year. The limits do go up periodically. But so that’s a lightning overview of how regular IRAs work now to invest directly in real estate through your IRA, you actually need a self-directed IRA rather than opening up a brokerage account through your regular investment broker.
Brian Davis: So, you first need to go and open an account with a self-directed IRA custodian who is a neutral third party, who knows and understands all of the IRS complicated rules for self-directed IRAs. They will keep you on the straight and narrow with your investing. So, the one that we actually recommend is called Millennium Trust Company. And then Deni will put a link to that in the comments. But the reason we recommend them is because they are used to working with real estate investors and they’re actually who Fundrise uses they are partnered up, so which is actually a segue into the next section here that the easiest way to invest in real estate through a self-directed IRA is actually through real estate crowdfunding, such as Fundrise, such as Streitwise, by the way, spelled like a STREIT. So clever, and ground floor is another good one. So, you can that’s way easier than buying properties directly with your self-directed IRA. So, if you’re just looking for an easy way to invest in real estate through a self-directed IRA, we recommend going through a real estate crowdfunding service like Fundrise, like streetwise, like ground floor. And by the way, we put links to all those in the comments as well. It’s way easier because it’s totally passive. You don’t have to go out and find deals.
Brian Davis: You don’t have to manage the property. But it also it’s easier on the rules side as well because there are some complications when you buy a property with your self-directed IRA. So how that works in broad strokes is you go out, you contribute your money to the custodian who holds your self-directed IRA. They control it. Um, you then create an LLC, and you instruct your custodian to invest your self-directed IRA funds into the LLC that you created. And then with that LLC, you go out and buy rental properties or even, you know, land or you can flophouses with it if you like. But you use the LLC to buy the properties and the money comes to your LLC from your self-directed IRA. Now there’s a couple of challenges here. One is financing. It gets really complicated when you’re using a self-directed IRA because you only get the IRA tax benefits that are proportionate to your down payment. So, for example, let’s say you buy a one hundred-thousand-dollar rental property, and you finance it with an 80 percent LTV loan. So, you go out and get a loan for eighty thousand dollars. You put down 20 thousand dollars of your own cash from the self-directed IRA, which means that you only get 20 percent of the property, and tax benefits fall under the IRA protection. The other 80 percent do not because you financed it with a loan so that accounting gets tricky and you know, the implications of all that could get tricky.
Brian Davis: And the loan in order to be legal, the loan has to be a non-recourse loan, which means that it can’t the lender can’t require you to sign a personal guarantee for the loan, which usually investment property lenders do require you to sign so that if you default, they can then go after your personal assets, not just after the property. So that all gets a little tricky. Um, and the other thing that’s tricky about buying properties directly with your self-directed IRA is that you can only contribute six thousand dollars a year to your IRA or 7000 if you’re over 50 and it takes a long time to build up enough money to even use towards a down payment for a rental property, much less buy one in cash if you can only contribute six thousand dollars a year. So, there are some wrinkles here. If you want to buy real estate directly with your real estate or your self-directed IRA. Now some other alternative ideas, raw land, which is something that DENI and I have been investing in more recently. Those costs are way lower. I mean, we’ve bought parcels for a thousand dollars, for example. So that’s way easier. When you’re talking about only contributing six thousand dollars a year to your IRA. You know, those lower increments, those lower price tags per piece of property make it much more feasible.
Brian Davis: It makes it a lot easier to avoid financing and all those headaches. You can also invest in any other type of real estate you want if the money in the math all works, you know, mobile home parks, commercial properties, you can flip houses with your self-directed IRA, although that too comes with some complications because you can’t personally add value is how the IRS puts it. You can’t add value to the investment. So that means you can’t do any of the work on the property yourself. If you’re handy, for example, you also can’t invest in anything through your self-directed IRA that reflects a regular business activity is how the IRS puts it. So, if you’re flipping 10 houses a year, you know, the IRS looks at that as a business, as a regular business activity, and that you can’t start doing that with your self-directed IRA. So, it gets it gets complicated. And there is some gray area. I mean, some people do flip homes with their self-directed IRA. But the line between what is an investment and what is a regular business activity, it gets blurry. So, you have to work really closely with your custodian and figure out exactly where that line is and stay on the right side of it. If you don’t want the IRS to come knocking at your door,
Denise Supplee: Which you don’t
Brian Davis: You definitely don’t. No, you do not.
Denise Supplee: Christina asks, what are you guys doing with raw land, leasing, or reselling?
Brian Davis: Do you want to take that, or do you want me to take that?
Denise Supplee: Sure, we’re buying it and we’re learning as we go along as well, but we are also selling it. We’re not building on it or anything. We’re reselling it as it is.
Brian Davis: Yes. Just to expand on what Deni said, we’re buying it not at tax sale, but we’re buying properties that are somewhat distressed that are behind on taxes. And so, we’re buying them at a deep discount and then we are flipping them. But people can either pay in cash for them or we are also offering to seller finance them. So that does create ongoing income from them as well. For the period of the note, the seller’s note. And the nice thing about Roland is that it doesn’t come with any of the regulations or protections that that residential real estate has. So, if someone gets halfway through your seller note, for example, you can just retake possession of the property and you’ll have to go through, you know, an extended eviction process or any of that. I mean, the legal process is very simple and fast. So, then you turn around for someone else and you’ve already been paid for half of it in that case.
Denise Supplee: So, it’s a win-win.
Brian Davis: Yeah, there are some advantages to raw land investing, and it makes a good option if you do want to invest in real estate directly with your self-directed IRA, but you want to deal with all the hassles of financing with rental properties. raw land can be a good fit for that.
Denise Supplee: Just like, you know, Brian, I am having a technical issue and I’m having trouble putting links. And if you are able to?
Brian Davis: Ok, no worries. So, you guys, a couple of links we have here for you that we’ve discussed in this broadcast. We talked about Millennium Trust Company, which is a custodian for self-directed IRAs, and they work closely with a lot of real estate investors. So that’s why we recommend them. And they’re also partnered with FUNDRISE to make this smoother and easier. If you do invest in real estate crowdfunding through your self-directed IRA it’s smoother and easier if you go through a company that’s used to that, Millennium Trust Company, putting a couple of links here to Fundrise to Streetwise and to ground floor, which, by the way, I invest in all of these myself as well. I’ve got my own personal money in each one of these real estate crowdfunding services. I am literally putting my money where my mouth is with these real estate crowdfunding services. I mean, this is stuff that I’m investing in personally. All right, Deni, is there anything else you want to add before we wrap this up about how self-directed IRAs work and how you can invest in real estate through one?
Denise Supplee: No, I think you covered it pretty well.
Brian Davis: All right. So, one final thought here. So personally, I invest in both stocks and real estate, and I would urge all of you to do the same. I mean, real estate and stocks actually complement each other really well. You know, there are pros and cons tend to complement well. So, if you’re going to be investing in stocks anyway, I would make your life easier and actually and not hassle with a self-directed IRA. I would just use a regular brokerage account for an IRA and use that for part of your stocks as part of your asset allocation that is in stocks and save yourself some hassle. You know, custodian’s also do they charge you an annual fee, which can be a flat fee. I think Millennium Trust Company charges one hundred twenty-five dollars a year, which is quite reasonable. Some others charge a percentage of assets under management or assets in your hold in your self-directed IRA, which can obviously get expensive quickly if you have a significant sum in there. So personally, I don’t use a self-directed IRA just because, you know, I’m investing in stocks anyway as part of my portfolio, as part of my asset allocation. So, I figure I might as well use the easy regular brokerage IRA account to do that. But, you know, some people feel very strongly that they can get better returns in real estate, and they want to have more control over it. So, they do they take advantage of a self-directed IRA and invest, whether it’s in properties directly or in real estate crowdfunding. And yeah. So, it’s one more option in your toolkit is how we look at it.
Denise Supplee: And we can use as many options as possible.
Brian Davis: Yeah, absolutely. And you know, none of us want to pay more taxes to Uncle Sam than we have to, so.
Denise Supplee: All right,
Brian Davis: Guys. Well, we will see you next Tuesday at two o’clock Eastern. Thanks for joining us. And let us know what you want to hear about next time. This is all about you guys. You know, it’s not just about us chatting. We get to chat all the time. So let us know what you want to hear about next Tuesday and we will catch you on the flip side.
Denise Supplee: See you later, guys.
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