The earlier you want to retire, the more proactive you need to be in funding your post-work life.
There are many ways to achieve financial independence for early retirement (FIRE). But many real estate investors wonder how they can put real estate in their IRAs.
Traditional IRAs and 401(k) accounts are hands-off investing accounts. They’re effective for people taking a slow-and-steady approach to retirement, but they lack the dynamic edge that appeals to most investors with FIRE goals.
Self-directed IRA retirement accounts allow you to invest in assets beyond stocks, bonds, and mutual funds. Which means investing in real estate with self-directed IRAs lets you combine the tax benefits of both fields.
Intrigued? Start with these basic questions to decide if a self-directed IRA (SDIRA) fits your goals.
How Much Real Estate Can You Own in a SDIRA?
Due to their generous tax advantages, real estate purchases with self-directed IRAs are heavily regulated by the IRS. Self-directed IRAs allow you to contribute the same amount each year as regular IRAs: $6,000 per year for adults under 50 in 2022, and $7,000 for adults 50 and over.
When the median US property costs over $400,000, it would take many years of maximum contributions to come up with a 20% down payment. Even the cheapest real estate in the US would be hard to buy with an IRA.
As you start researching ways to invest in real estate with an IRA, consider the following questions and ideas.
Have You Considered REITs?
Real estate investment trusts, or REITs, are the easiest way to diversify your IRA without buying and managing individual properties.
REITs are companies that own and manage income-producing real estate assets. When you invest in a REIT, you’re buying shares in the company, which gives you a piece of the profits from the real estate they own.
You can buy publicly-traded REITs through your regular IRA, without needing to open a self-directed IRA. That makes them the easiest option for adding real estate to your retirement accounts.
If you prefer real estate crowdfunding investments, such as Fundrise, Streitwise, or Arrived Homes, you can buy shares with an SDIRA. They make for completely passive investments and easy diversification, but you do need to create an SDIRA to invest in them.
Adding a REIT or two to your self-directed IRA can be a way to get real estate exposure without taking on the risk and responsibility of owning individual properties. It’s also an excellent way to diversify your portfolio and reduce your overall risk.
Coming back to the original question, you can hold as many REIT investments as you feel comfortable within your self-directed IRA. They’re passive, and you can invest with as little as $10, making it easier to invest in small amounts.
How Much Can You Put Down?
When you’re buying a property with your IRA, financing isn’t as straightforward as it is with other real estate investments.
Only the down payment you provide from a self-directed IRA will be tax-protected, leaving the remaining percentage of the property taxable. So, if you put down 20% and borrow the other 80% as a rental property mortgage when you buy, you only get IRA tax advantages on 20% of the property’s returns. You can still write off mortgage interest as a rental property tax deduction.
The ideal strategy for buying real estate with a self-directed IRA is to pay in cash. Paying in cash means the entire amount will be tax-protected by the rules of the IRA. But that’s not very practical, given the annual contribution limits to your IRA.
Can You Get a Non-Recourse Loan?
You can only finance real estate in a self-directed IRA with a non-recourse loan.
A non-recourse loan is only secured by the property, and doesn’t require a personal guarantee from you. If you default on the loan, the lender can’t go after your personal assets to recoup their losses.
Non-recourse loans may sound like a dream come true to eager real estate investors because of the protection they provide. However, few lenders issue non-recourse loans. Those that do often require steeper down payments than the standard 20% for a rental property mortgage.
This brings us back to the earlier point about paying in cash. You can still have some real estate in your IRA if you’re going the financing route, but the challenges of pursuing multiple non-recourse loans can make it challenging to have lots of real estate in your IRA.
How Does Real Estate Fit with Your Other Retirement Accounts?
Part of assessing your risk tolerance means being realistic about your other types of retirement accounts. For example, an employee-sponsored 401(k) could provide a secure safety net that allows you to pursue a higher volume of real estate investments in your IRA.
If you’re looking to add self-directed IRA real estate investments to an existing retirement portfolio, it’s essential to consider how other accounts will be affected.
For example, if you have a 401(k) account that’s invested in stocks and bonds that’s growing steadily, you can diversify your overall retirement portfolio with numerous IRA real estate investments.
Overall, your 401(k) and IRA should balance each other out. If you have a more conservative 401(k), it might be strategic to have a more aggressive IRA.
Does Your Custodian Specialize in Real Estate?
Not all SDIRA custodians allow their clients to invest in real estate. Some custodians have specific rules about the types of investments their clients can make, and others simply don’t have the experience or infrastructure in place to help you with a self-directed IRA real estate purchase.
Before deciding how much real estate you want in your IRA, it’s important to ask your custodian if they specialize in this type of investment. If they don’t, it might be time to find a new home for your IRA.
When you’re ready to start looking for a new custodian, it’s essential to consider the fees they charge and their experience with self-directed IRAs. Some custodians will charge a flat annual fee, and others will charge a percentage of the total value of your account.
It’s also important to ensure that the custodian you choose has experience with real estate transactions. They should be able to help you with everything from setting up an LLC to closing on a property. Buying under an LLC helps you keep funds separate, keeping you in compliance with IRS rules about using real estate bought with an IRA. Getting a mortgage for an LLC-owned company is easy, too.
It’s impossible to invest in real estate through an IRA without a custodian. If you have a custodian, how much real estate you can have in your IRA will be partially up to their discretion.
How Do You Intend to Use the Property?
Before investing in any real estate with your IRA, you should decide what type of property you want to buy. There are many strict rules about how an IRA-purchased home can be used. If these rules don’t allow you to get what you want out of the property, you’d probably prefer to have little to no real estate in your IRA.
Rules of use for IRA-bought properties include:
- You can only purchase investment properties, no personal-use properties
- You can’t personally fund any expenses to the property
- You can’t furnish the property with anything you already own
- You can’t let a friend or family member live on the property
These rules dictate that if you’re interested in investing in a property and getting a lot of personal use out of it, then investing in real estate with a self-directed IRA might not be the right choice for you.
Most investors prefer to invest in rental properties with self-directed IRAs. These properties offer consistent cash flow and long-term appreciation potential. Theoretically, you can purchase any property with a self-directed IRA, but if you’re not collecting rental income, you’re relying entirely on property appreciation for a return on investment.
If you’re interested in operating multiple rental properties, feel free to fill your IRA with real estate investments.
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How Much Passive Income Do You Want In Your Retirement?
Another way to decide how much real estate to put in your IRA is to determine how much passive income you’ll need during your retirement. This number can be tricky to calculate, but there are a few general rules of thumb to help you get started.
The average American retiree needs 80% of their pre-retirement income to uphold a similar lifestyle after they stop working. Say you earned $100,000 per year pre-retirement, then you’d most likely want to earn around $80,000 per year in retirement.
Suppose you’re interested in funding your entire retirement with passive income through self-directed IRA real estate investments. In that case, you’d need to ensure that they generate about $7,000 – $10,000 a month in rental to account for covering all the other associated expenses.
If that’s your goal, you should have $1 – $2 million worth of real estate in your self-directed IRA.
Do You Want to Hire a Property Manager?
The stringent rules of buying rental real estate with an IRA make property management more challenging. The IRS states owners of self-directed rental properties are prohibited from doing much (if any) hands-on improvements to the home. This means an owner wouldn’t be able to implement any high-ROI home improvements or even respond to tenant maintenance requests. Partnering with a rental property management company makes it easiest to stay compliant with IRS rules.
Working with a property management company has many upsides, especially for people who want to ensure that their rental income is as passive as possible.
Property management companies can take the hassle out of owning rental property.
They can help you find and screen tenants, collect rent and handle any repairs or maintenance issues that may come up. This can free up your time to focus on other things, like continuing to make money in your retirement years.
Working with a property management company usually costs about 10% of the monthly rent. So, if your rental property is bringing in $1,000 a month, you can expect to pay around $100 a month for property management services.
If you’re willing to work with a property management company, then you can be encouraged to pursue as many self-directed IRA real estate investments as you want.
If you prefer to independently manage tenancies, there are ways to do so within the IRS rules. However, it gets complicated fast. You’d be well advised to limit the volume of self-directed IRA real estate investments you have.
What’s Your Target Asset Allocation?
Asset allocation simply means the percentage of your portfolio made up by different types of assets.
For example, you might aim for 70% stocks, 30% real estate. Within each asset class, you’ll can diversify as well: you might want the stock portion of your portfolio to break down as half US stocks, half international stocks. On the real estate side, you might want some rental properties plus some real estate crowdfunding investments.
How does this affect how much real estate should go in your IRA? Because if you’re going to own both stocks and real estate, stocks are much easier to hold in an IRA. You can invest in stocks through a regular IRA with your brokerage firm, rather than going through the hassle of setting up a self-directed IRA.
Besides, real estate comes with plenty of inherent tax advantages, from deductions to ways to avoid capital gains tax. Many real estate investors use their IRA to hold stocks, and own real estate “normally.”
Should You Invest in Real Estate with a SDIRA?
The bottom line is that there’s no one-size-fits-all answer to how much real estate should go into an IRA. You need to ask yourself some crucial questions to determine the right amount for you.
By considering your unique financial goals and asset allocation, you can make an informed decision about how much — or how little — to invest in real estate through your IRA.♦
Have you decided how much real estate should go into your IRA? What are you aiming for?