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How to Choose the Right Investment for Your Real Estate IRA

Housing tract with one gold house

  |  By Chris Shanahan, CISP®

One of the most common questions I get asked by newer clients is around the different types of real estate investment vehicles that are allowed in a self-directed IRA. This was certainly the case a few weeks ago, when I spoke on a panel at the Opal Group’s annual Real Estate Investor Summit in Miami. The audience, a mix of real estate professionals, fund managers, fundraisers and individuals interested in income-based real estate investing, were very curious about some of the rules and logistics around using an IRA to invest in real estate. But the discussion that seemed to capture everyone’s attention was about the pros and cons of direct vs. indirect real estate investments in an IRA.

Direct investing is just what it sounds like: purchasing a piece of property for buy-to-rent or flipping purposes. This hands-on approach is typically the preferred method for investors who like to have a lot of control over the transaction. The way it usually works is that the investor will find a property, gather the required documents for the IRA custodian (including a purchase contract, settlement statements, escrow documents and more), sign them as “read & approved” and send them to the custodian for countersignature.

The name on the deed for the property will read “(IRA Custodian) FBO (client name) IRA,” and all expenses, tax bills, improvements, etc. must be paid from the IRA’s cash balance. Many custodians also require that in the case of a buy-to-rent investment property, a third-party property manager must be retained to gather rental payments from the tenant and disburse the rental income back to the IRA. This method puts the onus on the client to coordinate the transaction and to make sure that they are not committing any prohibited transactions. However it does give them much more freedom to buy/sell investment properties.

The second way to invest in real estate through an IRA is to place that money into a real estate fund or private equity entity that invests in real estate. These can be multi-billion dollar REITs, private LLCs/LPs, joint ventures, or other equity vehicles. Investing in this manner takes much of the stress and legwork away from the account owner, since the fund or investment company controls everything and chooses where and when to invest the client’s money. The LLC distributions and payments flow back to the IRA as normal, where they grow tax-free.

So which approach is right for you? Both methods give investors a tax-advantaged way to invest in real estate, but when choosing how you get exposure it really comes down to your preferred investment style. If you like having a lot of control and don’t mind the extra legwork, you may be happier with a direct real estate investment. If you want to be more hands off, a fund or private equity entity is probably the way to go.

This Blog does not provide investment, tax, or legal advice nor does it evaluate, recommend or endorse any advisory firm or investment vehicle. Investments are not FDIC insured and are subject to risk, including the loss of principal.

PENSCO Trust Company performs the duties of an independent custodian of assets for self-directed individual and business retirement accounts and does not provide investment advice, sell investments or offer any tax or legal advice. Clients or potential clients are advised to perform their own due diligence in choosing any investment opportunity as well as selecting any professional to assist them with an investment opportunity.  Alternative investments are not FDIC insured and are subject to risk, including loss of principal.  PENSCO is indirectly affiliated with a registered broker dealer and with a licensed small business investment company through Opus Bank (“Opus Affiliates”).  Other than the Opus Affiliates, PENSCO is not affiliated with any financial professional, investment, investment sponsor, or investment, tax or legal advisor.