Should You Use Your Self-Directed IRA to Buy Investment Properties While Interest Rates are Low?

The ability to invest in real estate is one of the most common reasons why retirement savers first start becoming interested in the self-directed IRA. An individual retirement account with a self-directed IRA custodian such as Quest Trust Company individuals to out their retirement funds to work in investments that traditional IRA custodians simply wouldn’t allow.

Adding to the desirability of investment real estate for retirement savers is that interest rates on mortgages and other types of borrowing continue to be quite low.

UBTI

Even if interest rates are low, you may not be able to derive the benefit you hope from borrowing money to buy real estate with your self directed IRA. This is because the tax laws that authorize individual retirement accounts put some limitations on how those accounts may be used. In particular, the activities of IRAs must be related to the fundamental purpose of the account, and that means to make investments. Borrowing money to make investments, however, is called out as an activity that’s at odds with the fundamental investment purpose.

As a result, when an IRA borrows money, the investment gains that result from that borrowing are considered to be unrelated business taxable income (or “UBTI”), which means that you’ll face a current year tax bill because of your investment borrowing. In many cases, this can greatly reduce or even exceed the advantages you gain by taking out a mortgage.

Investment Quality

If you choose to borrow money within your self-directed IRA in order to invest in real estate, be sure you are doing so because you are presented with a quality investment opportunity, rather than simply because interest rates are low. You should have a plan for how each piece of property you acquire is going to become a productive part of your portfolio, and your anticipated timeframe for that to occur.

Note that this doesn’t necessarily mean every piece of investment property you acquire needs to be productive right away. “Fixer uppers” are certainly appropriate for investment; just be sure you take into account any repair or remodeling costs into your financial analysis.

Fees

Regardless of how you choose to use your self-directed IRA to acquire investment properties, you should have a comprehensive understanding of the costs and fees that come with holding the property. For example, many real estate investors will tell you that as they build larger portfolios of property, they find that their costs on a per property basis tend to decline. This is because they are able to leverage certain economies of scale when it comes to property managers, repair and maintenance professionals, and other types of support they need in maintaining those properties.

Low interest rates can be a factor in deciding whether or not to buy investment real estate with your self-directed IRA, but it should not be the only factor.

Finding a Property Manager for Your Self-Directed IRA Real Estate Portfolio

property managerThe potential upside and cash flow possibilities of investment real estate make it a highly attractive option for retirement savers who have self-directed IRAs. Unfortunately, some investors may be somewhat reluctant to invest in real estate because of the higher level of attention that particular asset class demands.

Unlike equity and debt investments, investing in real estate involves a physical asset that the owner is responsible for maintaining, promoting and safeguarding. The most common solution to these issues is for real estate investors to retain the services of a property manager. Here are some options for finding the right manager for your self-directed IRA real estate portfolio.

Hire an Individual. If your real estate portfolio is relatively small, you might be able to hire someone you already know to manage the property. Sometimes a local handyman can be all the assistance you need to manage a single property. If you choose an individual manager, then be sure that person carries an appropriate type and amount of liability coverage.

Hire a Property Management Service. If you own multiple properties, or are looking for a higher level of service, then you should look to hire a professional property management service. As you might expect, the property management industry is fairly well developed. This means that for practically any area of the country you’ll be able to find a service that can manage your real estate holdings. Make sure to understand the services that are available, as well as the fees that you will be responsible for.

It’s worth noting that a professional property manager may also be able to provide you with valuable assistance if you ever find yourself in a situation where your tenant is not complying with the terms of their lease. A manager that has experience with eviction or similar proceedings can be invaluable.

Understand What You’re Looking For. Before you start trying to find a property manager for your real estate investments, you should evaluate the types of services you need. The first step is likely to be making a list of all the maintenance and upkeep obligations that you are responsible for as the property owner. For example, if your rental property is a condominium, or a single-family home that’s subject to homeowners association (HOA) rules, then you need to be confident that your property manager will be able to meet all of those obligations.

If you own a multi-family home or apartment building, there may be some local or state regulations that you also need to satisfy. If you’re not familiar with these duties, an experienced property manager can help you bridge the gap in your expertise.

Finally, there’s one last option to consider – managing your real estate investments yourself. You won’t be able to pay yourself any compensation from your self-directed IRA (whereas fees can be paid to a third party property manager), but you might find that you have fewer worries about your investments knowing exactly what’s happening with them.

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