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Self-Directed IRA Real Estate Traps to Avoid

Real estate has always been at the pinnacle of investments for those who aren’t a fan of the stock market. In fact, many self directed IRAs are very popular for the investment of real estate. Today, we are going to take a look at some of the traps you should avoid when investing your retirement money in a real estate venture.

Know the Taxes

There’s nothing worse than thinking you are going to have a lot more money than you actually are because you forgot about the taxes. Depending on the retirement IRA that you have setup, taxes are handled differently for real estate transactions.

With Roth IRAs, all gains from your retirement account are considered tax-free. This is because the total balance in the account is what you contributed after paying taxes out of it. With traditional IRAs, this is not the case. The balance in the account hasn’t been taxed yet, so any earnings from your real estate investment will be taxed at the time you retire following the normal rate structure.

Only Purchase with Cash

If you are thinking of using real estate as part of your investment scheme, it’s important to realize you only want to use existing money in your IRA account. Some have gone to using debt as a way to finance their real estate ventures. This is not a good idea.

While it is possible to borrow debt with your IRA account, you will be taxed for any real estate income that you gain. This is due to the unrelated business income tax that takes 39.6 percent of the income you earned from the real estate.

You Lose the Real Estate Tax Advantages

When you use your IRA to fund your real estate endeavors, the Government will deny any tax advantages that it offers to those who don’t use an IRA for funding. These tax advantages include the 1031 Exchange and Real Estate Depreciation. It’s important to take into account the tax advantages that you can utilize if you were to fund your real estate ventures through another account and decide what is best for you to use.

No Self Fixing Up 

If you have heard of sweat equity, you know what we are talking about. If not, sweat equity is when you, as the homeowner, personally perform work that increases the value of the home. This is why most investors will purchase a home. They want to buy it for a low price and fix it up to receive a higher sell value later down the road.

Unfortunately, it’s not that easy. According to the United States Government, you cannot perform services for your own IRA. By using your sweat equity, you are technically providing a service to the investment in your IRA portfolio. This is illegal to do and can put a hinder in your investing plans. You must hire out to improve the components of your investment home to increase its value.

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