On June 8, 2022, the Mortgage Bankers Association announced that a measure of mortgage applications fell to its lowest level in 22 years in early June 2022. “Mortgage applications fell 6.5% in the week ended June 3, the fourth consecutive week of declines. Refinance and purchase activity fell 6% and 7%, respectively.” To many real estate investors, this is a clear sign that the U.S. housing market is coming back to Earth after a two-year boom stretch. What does this mean for Self-Directed IRA real estate investors with cash?
With equity markets being slammed in 2022, more and more IRA investors have been turning to real estate as a way to better diversify their IRA assets and gain greater protection against inflation. The biggest advantage IRA investors have when entering the real estate marketplace is cash.
- Mortgage applications are down due to higher interest rates
- Self-Directed IRA real estate investors with cash have the advantage
- Using retirement funds to invest in real estate is a tax-advantaged way to generate income and diversify
What is a Self-Directed IRA?
In short, a Self-Directed IRA is a tax-advantaged retirement plan that gives savers the ultimate investment freedom. Not only can you invest in traditional assets, like stocks, bonds and ETFs, you have the opportunity to invest in nontraditional, or alternative, investments, such as real estate.
Most IRA accounts opened at a local bank or online retailer limit your investment options. However, when you self-direct you account, your investment world opens up. When working with the right custodian, such as IRA Financial, you can invest in anything that is not prohibited by the IRS.
Real estate has always been the top dog among investors. The higher interest rate environment might have a positive impact on IRA investors…but only if you have cash.
Cash is King for Real Estate
With interest rates on the rise, it’s much better to have cash on hand (or in your retirement plan) to make real estate investments. No mortgage or other financing is the way to go. When you have the ability to offer cash for a property, you can quickly move on an investment opportunity.
Speed is essential to purchasing a property. When given the choice between a cash deal and 10% down, who do you think has the better chance of landing that property?
Plus, you don’t have to worry about taxes with an all-cash deal. This is because an IRA real estate investment that uses leverage is subject to the UBTI tax. If there’s no leverage, you won’t have to worry about taxes for as long as the property is held by the IRA.
Self-Directed IRA Real Estate Tax Advantage
The primary advantage of using a Self-Directed IRA to make investments is that all income and gains associated with the IRA investment grow tax-deferred, or tax-free in the case of a Roth IRA.
With the IRA Financial Self-Directed IRA LLC solution, traditional IRA or Roth IRA funds can be used to buy real estate throughout the United States in a tax-advantaged account. Over the years, our real estate IRA clients have been able to use cash to find attractive real estate opportunities while gaining the opportunity to move quickly on a potential investment.
There are two types of IRAs you should be aware of – the custodian controlled IRA and the Checkbook Control IRA.
The Self-Directed IRA
A “regular” Self-Directed IRA offers an IRA investor more investment options than your typical IRA. A special IRA custodian, such as IRA Financial, will serve as the custodian of the IRA. Unlike a typical financial institution or brokerage firm, IRA Financial and other passive custodians generate fees simply by opening and maintaining IRA accounts and do not offer any financial investment products or platforms.
The IRA funds are generally held with the IRA custodian and at the IRA holder’s sole direction, the custodian will use the plan funds to make the investment on your behalf. Generally, this is a good option for those with a lower frequency of transactions annually.
Checkbook Control IRA
A Self-Directed IRA LLC with “checkbook control” is the most popular vehicle for investments that have a high number of transactions. Included in that are many real estate dealings, including rentals and renovations. You have the freedom to use your IRA funds whenever you see fit. For example, paying a contractor or rental management company can be done without the need for custodial consent.
Under the Checkbook IRA format, a special purpose LLC is created which is funded and owned by the IRA and managed by the IRA holder. It offers the IRA investor with limited liability protection, which is especially important for real estate investments.
In addition, the structure allows the investor to act quickly when the right investment opportunity presents itself cost effectively and without delay. This is especially important in the case of a cash offer real estate investment.
Home prices are up about 40% since the pandemic started, according to the National Association of Realtors. However, with interest rates on the rise, you can expect the market to cool off considerably this summer (despite the rising temperatures). Having cash to make a real estate investment may be just thing you need to take advantage while the market is still prime.
Obviously, one should talk with a professional before deciding on any investment decisions. Do your diligence to make sure you are making the right choice for your specific situation. Just because you can do it, doesn’t necessarily mean you should!
If you have any question, please fill out the contact form below.