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How To Finance An Investment Property With A Self Directed IRA

Disclaimer: Individuals should consult a tax professional before getting started with a self directed IRA.

There is no shortage of financing options in real estate. From conventional loans to private and hard money lenders, there are countless ways to secure working capital in real estate, including a few overlooked alternatives. For those wondering how to finance an investment property, one of the lesser known methods has to do with self directed IRAs.

This strategy essentially permits real estate to be held inside IRA retirement accounts, with funds from a self directed IRA used to acquire real estate properties. This approach also allows investors to defer (or eliminate) taxes, making it advantageous on many levels. For investors pondering how to finance an investment property, the use of a self directed IRA can be an excellent alternative to traditional financing.

How To Finance An Investment Property With A Self Directed IRA

Investment property financing

Before explaining how to finance an investment property with a self directed IRA, it’s important to first understand the benefits of using one. To begin, a self directed IRA can be used in various segments of real estate, including the following:

Along with multiple investment options, the appeal of using a self directed IRA to purchase real estate includes several additional advantages:

More Control: Rather than investing in traditional retirement options like ETFs and mutual funds, which are typically focused on subtle returns, a self directed IRA offers the ability for investors to leverage their retirement with alternative investments, specifically through real estate.

Tax Benefits: One of the biggest benefits of using a self directed IRA to purchase real estate is in the form of tax savings. This investment style allows for tax-deferred or tax-free growth with investments, including rental income and capital gains. Although tax deferral with a self directed IRA applies only to money you’ve contributed, it can be an excellent source for investors when starting out.

Protection: A self directed IRA, by definition, is a trust; it’s protected from federal and state bankruptcy law, which allows it be a separate entity from the owner.

Better Returns: Instead of your nest egg earning small returns, the use of a self directed IRA can boost returns for investors at a faster rate. Done right, this approach may produce sizable returns, especially in comparison to traditional IRA investments.

As an investor, there are several benefits to using a self directed IRA to acquire real estate. While this approach may not align with everyone, this investing strategy offers an assortment of advantages compared to traditional financing methods.

5 Steps To Financing An Investment Property With A Self Directed IRA

For investors considering financing an investment property with a self directed IRA, here are the five steps to getting started:

Step One: Begin The Paperwork

The first step to financing an investment property with a self directed IRA is the paperwork. In most cases, this will begin with an investor locating a property, drawing up a purchase agreement and agreeing to an earnest money deposit. It’s important to note, however, that funds for the deposit must come from the IRA’s cash balance rather than their personal checking account.

The next task when using a self directed IRA is to sign all purchase contract documents, including the countersigning by an IRA custodian. Because IRS regulations require a custodian to hold the IRA assets on behalf of the self directed owner, they will essentially perform the administrative duties, including any addenda or amendments to the purchase contract.

Step Two: The Deposit

The next component to consider is the deposit. IRA account owners will need to send the earnest money deposit funds to the title/escrow company using their IRA custodian. That said, it’s critical that sent funds are not from an IRA account owner’s personal account, as this will essentially constitute a prohibited transaction.

Step Three: The Review

This is the stage when everyone on both sides dots their i’s and crosses their t’s. This step will include the IRA custodian reviewing all documents to ensure the investment is suitable for administration, including no prohibited transactions. Known as the review process, this stage includes a preliminary title report for the property (confirmation the seller is on the title and is not a disqualified person), a proposed grant deed (which will highlight who the buyer/owner is, who the custodian is, including the owner’s address), escrow instructions from the title/escrow company (with initials and signatures), a final settlement statement (with initials and signatures), and completed custodial forms.

Step Four: Management

Once all the funds from the self directed IRA are in escrow and documents have been signed, including the grant deed, investors can begin moving forward with their investment. At this stage, they are free to sell the property, rent it or lease it as they choose. However, according to the rules of self directed IRAs, investors seeking to rent or lease a property are required to enlist the help of a third-party property manager to gather rental payments and forward them to the IRA. This process ensures all income from the property is paid to the IRA account.

Step Five: Due Diligence

Like any investment in real estate, the importance of performing the necessary legwork in the beginning stages is critical to success. As a real estate investor, it’s critical that due diligence is always a check box on your to-do list, as this will essentially ensure you’re not sabotaging your investing efforts. In addition, especially when it comes to using self directed IRAs to finance real estate, it’s important for investors to consult a tax professional before getting started.

While the real estate market offers a slew of financing options for investors, the use of a self directed IRA remains one of the lesser known options. For those curious how to finance an investment property, this little-know method can help jumpstart an investor’s career, including producing significant tax benefits.

Disclaimer: Individuals should consult a tax professional before getting started with a self directed IRA.

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