Is a large amount of your wealth invested through your IRA or 401k with limited investment options? If you’re like most people, then the answer is yes. Well, did you know it is possible to invest your IRA or 401k in all kinds of alternative investments, including multifamily real estate funds?
How, you ask? By setting up a Self-Directed IRA and investing through that real estate IRA.
There are a number of reasons you may want to consider this. First, the investment horizon for IRA’s tends to be more in line with most people’s views on real estate investing. Second, many people have a lot of money in their IRA or 401k’s. Finally, you may be able to defer the taxes on some or all the gains from investments made through these Self-Directed IRA’s.
In this article, I will introduce you to the concept and discuss some of those reasons why you should consider this.
Why Invest in Real Estate in a Self-Directed IRA?
I like the concept of using a Self-Directed IRA to invest in a real estate fund for a number of reasons. First, investing in real estate funds is usually not an “active trading” type of investment. You make the investment and let it work for you for at least 3-5 years before it is sold. That is usually consistent with people’s approach to their IRA. The time horizon most people have with their IRA is longer in nature and so it seems to be a good match. I like matching investors’ time horizons with an equivalent investment time horizon.
Second, many people have most of their wealth in their IRA or 401k. As it turns out, real estate requires a lot of capital, and it is common for people to invest $50,000, $100,000 and even more in a single real estate fund investment. Again, investing through a Real Estate Self-Directed IRA seems like a match – investors have a lot of capital in their IRA’s and so investing in investments like real estate funds that require a lot of capital seems like another match.
Third, it is very possible to build massive wealth through multifamily real estate investing, especially over the long term. We all know many famous business people who have made a ton of money in real estate over their lifetime. They may not have become rich on one investment, but, over time, they have used real estate to build massive wealth for themselves.
Now, I ask you, isn’t that the purpose of an IRA? To build wealth over the long term so you can use that money later in life to enjoy your retirement years. Above, I talk about matching investment goals, time horizons, etc. in determining what you should invest in. This does seem to check all the right boxes.
- You probably have a lot of wealth in your IRA
- Real estate fund investments generally have a longer time horizon
- You can build massive wealth investing in real estate funds
So far, a pretty compelling case, which is why we have had many investors invest in our deals through a Self-Directed Real Estate IRA!
Tax Considerations When Investing in Real Estate Funds Through a Self-Directed IRA
Like everything in life, there are always tax considerations I want you to be aware of. I won’t do a deep dive on the topic, but I do want to at least introduce you to the topics and encourage you to consult your tax advisor.
Generally, a Self-Directed IRA offers the same tax advantages as any other IRA. That means that income is not subject to tax until you withdraw the funds from the IRA. Great news so far!
There is one notable asterisk here though and that relates to using a Self-Directed IRA to invest in an asset that incurs debt to earn that income. In that case, the investment is said to generate “Debt Financed Income” which, in the IRA tax world, is known as a type of “UBTI”, or “Unrelated Business Taxable Income.”
Generally, all that means is that a portion of the income earned in your Self-Directed IRA for real estate may be subject to tax to the extent that income is earned through debt financed investments. For example, if you invest in a real estate fund that buys an apartment building using a mortgage loan in the amount of 60% of the purchase price, then 40% of the income from that real estate investment will be tax deferred. So, although it may not allow you to defer all the tax on the income, in the example I gave, you could defer almost half of it! Nothing wrong with saving 40% in taxes!
One last thing to remember, real estate investments still get the same depreciation benefits regardless of whether it is held in a real estate IRA or a non-IRA account.
What does all this mean?
The main takeaway from this tax discussion is that you should be aware that there are tax considerations to discuss with your CPA, but I never make tax considerations the number one consideration when making investment decisions. The investment should always make sense economically first and foremost. Once you decide it does, then just make sure you understand the tax issues and do what you can to mitigate them. I never like to see when the “tax tail wags the dog” which sometimes happens to people.
Again, we have numerous investors in our past and current deals and Fund that are investing through their Self-Directed Real Estate IRA and I recommend that you consider it for yourself. There are numerous providers out there that can walk you through the process. If you need a referral, please don’t hesitate to reach out to me and I will give you some good options.
