How to Invest in Real Estate Syndications Using a Self-Directed IRA

Real estate syndications offer an exciting opportunity for investors to diversify their portfolios and generate passive income. By pooling resources with other investors, you can gain access to larger, more lucrative real estate deals that would be difficult to tackle alone.  

However, understanding how to effectively leverage these accounts for investing in real estate syndication can be challenging without the right guidance. In this blog post, we’ll explore how you can invest in real estate syndications using a Self-Directed IRA, often referred to as a “Real Estate IRA.”  

We’ll guide you through the process, from understanding the different types of accounts available to learning the specific steps required to hold real estate in your IRA.  

What is a Self-directed IRA? 

A Self-Directed IRA (SDIRA) is a traditional IRA that permits the client to invest in a broader array of investments than any conventional IRA.  

While a typical IRA allows you to invest only in equities, bonds, or mutual funds, an SDIRA expands your options to include such assets as: 

• Real estate 

• Precious metals 

• Cryptocurrencies 

• Private companies 

Nevertheless, this variety of investments does possess intricate regulations with which you must acquaint yourself. For instance, the utilization of SDIRA funds for procurement of gold, silver, or platinum coins, which are then retained within your SDIRA as an investment, could be an appealing strategy.  

However, the acquisition of precious metals using an SDIRA account may be interpreted as a taxable withdrawal, provided the IRS categorizes these metals as collectible. 

The intricacy associated with such decisions underscores the necessity of engaging with a financial advisor and tax expert if one chooses to operate a self-directed IRA. Their expertise will enable you to fully comprehend the repercussions of your investment determinations. 

How a Self-Directed IRA for Real Estate Works 

Investing in real estate through an SDIRA involves several key steps. Here’s a simple guide on how to set up a Self-Directed IRA: 

1. Open a Real Estate IRA 

Before you can invest in real estate, you need to set up your SDIRA. This can be done quickly and easily online. Once your account is open and funded, you’re ready to start exploring real estate investment opportunities. 

2. Choose Your Account Type 

Decide whether you want a traditional IRA, Roth IRA, or Individual 401(k) for your real estate investments. Each has its own tax advantages: 

• Traditional IRA: Contributions are tax-deductible, and you pay taxes when you withdraw funds. 

• Roth IRA: Contributions are made with after-tax dollars, but withdrawals are tax-free after age 59½ if the account is over five years old. 

• Individual 401(k): Ideal for small business owners, offering similar tax benefits to a traditional IRA but with added flexibility for real estate investing.

3. Fund Your Account 

You can fund your SDIRA by transferring funds from another IRA, rolling over funds from a 401(k), or making annual contributions within IRS limits. 

4. Learn the Rules and Regulations 

Be aware of IRS rules regarding prohibited transactions and disqualified persons. For example, you cannot personally benefit from a property owned by your SDIRA, and all income and expenses must go through the account. 

5. Do Your Due Diligence 

Research your investment options carefully to ensure they align with your financial goals. Consider consulting with a financial advisor to help navigate the complexities of SDIRA real estate investments. 

How To Leverage Your Self-directed IRA To Invest Passively in Real Estate Syndications 

Investing in real estate syndications through your Self-Directed IRA (SDIRA) allows you to participate in larger deals and benefit from passive income. Here’s how it works: 

1. Access to Larger Deals 

By pooling your funds with other investors, you can participate in substantial real estate projects that might otherwise be out of reach. This allows for greater diversification in your investment portfolio. 

2. Professional Management 

Syndication typically involves a lead investor or sponsor who manages the property on behalf of all investors. This is especially beneficial for those who lack the experience or time to manage real estate investments themselves. 

3. Minimized Risk 

In syndication, your financial responsibility is limited to your share of the investment. This means that if the property underperforms, any losses are spread across all investors, reducing individual risk. 

4. Passive Income 

Since the lead investor handles all aspects of property management, including maintenance and rent collection, you can earn passive income without active involvement. 

5. Tax Benefits 

Investing in real estate syndications through an SDIRA can offer tax advantages, such as deductions for mortgage interest and property taxes, which can enhance your overall return on investment. 

Benefits & Risks of using Self-Directed IRA funds in Real Estate 

Using Self-Directed IRA funds to invest in real estate offers a unique opportunity to diversify your retirement portfolio and potentially earn significant returns. However, you must understand both the benefits and risks involved in making smart investment decisions. 

1. Depreciation Deductions 

Generally, the IRS permits depreciation in the case where a property’s value depreciates over a specific time due to deterioration of its form through use in a business.  

This depreciation deduction can be claimed up to a large proportion of your taxable income in a year and hence is a tax relief. Depreciation allows for the retention of more of the investment profits, which is, therefore, an important boon to real estate investors. 

2. Property Tax Deductions

For real estate investors using a Self-Directed IRA (SDIRA), property tax deductions can be a valuable benefit. When you invest in real estate through your SDIRA, including commercial properties, the property taxes you pay are deductible.  

This means that the amount you spend on property taxes can be subtracted from your taxable income, potentially reducing your overall tax liability. 

3. Tax-Deferred Growth 

One of the key advantages of using a Self-Directed IRA (SDIRA) for real estate investments is tax-deferred growth. With this structure, you won’t owe taxes on any earnings or profits generated by the property until you withdraw the funds from your IRA.  

This means that all rental income, capital gains, and other returns from the investment can continue to grow within the IRA without being diminished by immediate tax obligations. 

4. Capital Gains Tax Deferral 

Capital gains tax deferral is a significant advantage when investing in real estate through a Self-Directed IRA. When you sell a qualifying investment property and reinvest the proceeds into another qualifying property, otherwise called a 1031 Exchange, you can postpone paying capital gains taxes on the sale.  

This means you don’t have to pay taxes on the profit from the sale until you eventually sell the new property, provided it meets the IRS criteria for tax deferral. 

5. No UBIT 

Unrelated Business Income Tax (UBIT) is a tax imposed on income earned by an IRA from activities that are not directly related to its tax-exempt purpose. Typically, UBIT applies to income generated from business activities or investments that are not considered passive.  

However, when you invest in real estate through your Self-Directed IRA (SDIRA), the income generated from rental properties is generally exempt from UBIT. This is because rental income is classified as passive income, which aligns with the investment’s exempt use.  

6. Reduced Tax Rates 

When you invest through an SDIRA, any rental income generated by the property is sheltered from immediate taxation. This means you won’t pay taxes on the income while it’s held within the IRA.  

When you eventually withdraw funds from your SDIRA, the tax rate on these distributions may be lower if you’re in a lower tax bracket at that time compared to when you initially made the investment.  

For instance, if you are in a lower tax band during retirement than when you were actively earning income, you could benefit from paying a lower tax rate on the distributions. Over time, this can lead to substantial tax savings, enhancing the overall return on your real estate investments. 

7. Estate Planning 

One significant advantage is that heirs can often inherit commercial property tax-free if it is held within an IRA. This can provide a substantial benefit for investors looking to pass their wealth on to future generations.  

By keeping real estate investments within an SDIRA, you can potentially avoid estate taxes that would otherwise apply to inherited property. This means that your heirs could receive the full value of your real estate investments without facing the tax burden that typically accompanies such assets.  

Learn the Self-Directed IRA Rules and Regulations 

Understanding the rules and regulations for investing in real estate through a Self-Directed IRA (SDIRA) is essential to ensure compliance and optimize your investment strategy. Here are the key rules to keep in mind: 

1. No Transactions with Disqualified Persons 

Your SDIRA cannot purchase property from or sell the property to you or any disqualified person. Disqualified individuals include: 

• Yourself 

• Your spouse 

• Your descendants 

• Certain other family members 

This rule is in place to prevent “self-dealing” and ensure that transactions are conducted at arm’s length. 

2. No Indirect Benefits 

You cannot personally benefit from the property owned by your SDIRA. This means you cannot use the property for personal use, such as a vacation home or rental office space. Any transaction that benefits you or a disqualified person is considered an indirect benefit and is prohibited. 

3. No Self-Performed Work on the Property 

You cannot perform maintenance or renovations on real estate purchased with your SDIRA. Providing services or “sweat equity” on a property owned by your IRA is considered a prohibited transaction. However, you can handle “desk work” related to your investment. 

4. Correct Titling of Investments 

All real estate investments must be titled in the name of your SDIRA, not your personal name. The correct title format is: “STRATA Trust Company Custodian FBO (for the benefit of) [Your Name] IRA.” 

5. Partial Funding is Allowed 

You can purchase property with your SDIRA without needing to fund the entire amount from your account. Options include: 

• Undivided Interest: Co-invest with other investors, sharing ownership and profits proportionately. 
• Partnerships: Combine SDIRA funds with other sources, such as personal funds or other retirement accounts. 

6. Property Expenses and Income 

All expenses related to the property (such as maintenance, taxes, and utility bills) must be paid by your SDIRA. Similarly, all income generated from the property, including rent and sale proceeds, must be deposited back into your SDIRA. 

FAQs: Real Estate Investments & SDIRAs