Many retirement savers may find that their best opportunities for real estate investment come from smaller properties and transactions. Let’s examine some of the ways you can use your self directed IRA to make smaller investments in real estate.
Concerns With Financing
One big reason that many self-directed IRA account owners look for smaller real estate investments is financing. When the individual retirement account does not have sufficient assets to purchase the subject real estate outright, and has to borrow or take out a mortgage in order to close the transaction, there can be significant negative tax consequences.
Investment financing within an IRA is considered to be “unrelated business taxable income” (or “UBTI”), which gives rise to an immediate year tax liability. In order to avoid UBTI, the account holder can limit themselves to real estate purchases that they can make outright with the assets in their account. This might include smaller residential properties, or perhaps even just undeveloped properties. In the case of undeveloped properties, the account holder may have to adjust their investment outlook to a longer focus.
Buy Into an Investment Group
Another strategy for using self-directed IRA to make smaller investments in real estate is to pool your funds with other investors. By doing so, the investment group will have the resources to be able to purchase larger properties. This technique allows your individual investment to stay small and manageable, but potentially has no limit on how large of an investment the group can make.
This type of collective investment strategy can be accomplished through a private group or a real estate investment trust (“REIT”) that is traded on a public stock exchange.
Watch the Fees
Seasoned real estate investors understand that once they own a certain number of properties, administration of those investments becomes more efficient due to economies of scale with respect to property managers, maintenance fees, and the like. As you begin to invest in smaller properties, you need plan for the fees you’re likely to incur, and be sure that the investment makes financial sense.
You must also be confident that you’ll have the capability of paying all of those fees directly from your account. Paying such fees from outside of the account can trigger negative tax implications.
Understand Why You’re Making the Investment
Finally, as with any other investment you make in your self-directed IRA, it’s important to understand exactly why you are doing so. For smaller properties, what is your exit strategy? When will it be appropriate to dispose of the property, and under what conditions or circumstances?
Your self-directed IRA can be used to purchase properties of all sizes and types, although the planning and administration you need to do for smaller properties will be different.