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When you use a Self-Directed IRA, you’ll have the freedom and flexibility to invest in a wider range of alternative asset classes than many investors are used to. This can include real estate, which means investing in single-family homes, multi-unit homes, apartment buildings, condominiums, or even raw land and commercial property. In other words, investing in a Self-Directed Real Estate IRA can provide you with the freedom to extend the diversification of your retirement portfolio far beyond what you previously imagined.
But what does it look like in practice? Let’s explain the ABCs of investing in a Self-Directed Real Estate IRA. Here are the basics to keep in mind.
Perhaps the most appealing aspect of the Self-Directed IRA for real estate investing—sometimes known as a “Real Estate IRA” by nickname—is the freedom you have within this account. That freedom means expanding to Real Estate as a retirement asset class. This extends the tax benefits of a retirement account to owning real estate, which in turn helps you squeeze more of the potential returns of this investment from the purchase you make within the account.
Of course, not everything is going to be allowable when you’re talking about the tax benefits made possible through Self-Directed Real Estate IRA investing. Since you’re turning over certain real estate to a retirement portfolio, it only makes sense that you can’t use these assets for your personal benefit. After all, you can’t take money out of a 401(k) without paying penalties on that money. It’s the same reason you’ll be expected not to use your real estate within a Real Estate IRA personally. Doing so would create a short-term benefit that invalidates the tax protections on the account.
Let’s take a look at a practical example of how this works. Say you invest in a single-family home within a Real Estate IRA. If you can’t touch it with your personal assets, how does it work? You would work with a property manager, who collects income, pays expenses on behalf of the real estate, and any profits would go to your retirement account tax free or tax deferred—depending on the account type. This situation shows the degree of separation you should maintain between your retirement investments and your personal accounts.
When you own real estate through a Real Estate IRA, it is not real estate you own free and clear and able to use for yourself. For example, neither you nor any disqualified person on the account (such as a child) will be able to use the property. For instance, if you have a single-family rental unit within your Self-Directed Real Estate IRA, you wouldn’t be able to let your daughter live in it. This creates the immediate short-term benefit we were talking about in the previous section.
While a Real Estate IRA is not a shortcut to tax savings without consequences on how you can use the real estate, it is still a powerful and wonderful way to keep tax benefits for real estate investment properties that you keep separate from your personal properties. And this is, after all, the idea behind using a Real Estate IRA.