Hey, guys. Welcome back.
Today, I'm going to talk about self-directed IRAs
because I'm always hearing people say,
hey, I'm going to put my real estate in a self-directed IRA
or I want to contribute to a self-directed IRA so I can invest in real estate.
And while it might be a good idea, I'm actually going to offer a
pretty controversial opinion on it, which is a lot of times it may not make sense.
And that is because real estate is such
a beneficial investment from a tax standpoint,
not just from a financial standpoint, because there's already
so many benefits allowed through the tax law that investing in real estate,
which already receives those advantages through tax deferred retirement accounts,
actually it can potentially or raise those benefits.
The first reason you may not want to invest in real estate through an IRA
is because of depreciation deductions, which we've talked about before.
Right. So those are those magical deductions.
That's based on the cost of the property, not necessarily what you invested,
but the total cost.
Right. Your downpayment plus debt.
You can depreciate that cost.
Sometimes you're able to use that depreciation
not only to offset the income from your rental property,
but you may also be able to use that to offset other income.
For example, if you have other rental real estate,
you may be able to use it to offset positive taxable income over there.
If you're a real estate professional or if you're active in real estate,
you may be able to deduct against other types of income
like wages or maybe other business income.
But when it's in a self-directed IRA,
it's it's trapped in its own box, which is separate from you.
It's a separate entity and separate taxpayer.
So you can't use those deductions to offset your other income.
And even if you have other income or other investments
in the retirement account, well, it's a tax deferred account.
So deductions in there are basically useless to you most of the time.
That retirement account isn't taxable anyway.
Which leads me into my next point, which is leverage.
Most of the time you're going to use leverage or debt
to purchase real estate while when it's in a self-directed IRA,
you have a concept called unrelated business taxable income
and you BTI one of the items that falls into this category
is essentially income that is generated from debt.
So what the IRS requires you to do is to calculate
how much of the income in the retirement account as a result of using debt.
And if you're over a certain amount or you may have to pay tax on that
at the applicable tax rates for UPI,
if you're using leverage for real estate anyway.
And the whole point of using a retirement account is to not pay tax,
well then if you're generating this unrelated business taxable income
because you're using leverage to buy real estate, then you're basically
making it pointless to invest through the retirement account
unless that's a very small portion, you're using very little leverage.
The third reason that you might want to avoid using a self-directed IRA
for real estate is because the sale of real estate
is actually subject to preferential tax rates.
Most of the time, this means that you actually pay
a lower rate of tax when you sell real estate
than you do on other types of income, like from your job or business income.
And this is referred
to as the capital gains tax rate, which depending on which tax bracket you fall
in, maybe 15 to 20% lower than the rate you're paying on other income.
Contrast this with when you take money out of a retirement account,
it's ordinary income, which means that
the graduated tax rate that's not out of preferential tax rate.
So if you invest in real estate and you sell real estate
in your retirement account and then you take a distribution
in retirement, you're paying ordinary tax rate.
So you've effectively converted what would have been a capital gain
if you had invested outside of the retirement account,
which would have been taxed a lower rate
to higher rate income by doing it through the retirement account.
So the only real benefit that you're getting if you do that
is potentially the time value of money, where if you sell the real estate now
but you don't take a distribution
for 20 years from now, then okay, maybe it's worth it.
But in the meantime, what are you investing in for that 20 year?
While if your intent was to do a self-directed IRA,
probably investing in more real estate, it's really you're just pushing off
capital gains that you would have paid at a lower rate.
And then you're recognizing it all at a higher rate later in retirement.
And lastly, for self-directed IRAs,
there are a lot of rules restricting what you can do.
And this can really handicap you sometimes and change
your investment plan to something that you may not otherwise do.
I won't go into a lot of details on these.
You'll definitely want to check it out.
And before you open up a self-directed IRA,
they have a lot of things that fall under what are prohibited transactions.
So for example, you can't derive any type of benefit
from real estate that's owned by your self-directed IRA.
So you couldn't, for example, invest in a property
and rent it out as an Airbnb most of the year.
And then every now
and then when it's not used, go use it as your own vacation home.
That would be a prohibited transaction because you're receiving
a personal benefit from it.
You also cut it rent out a portion of the either,
whether it was for a retreat for your business
or if you had an office building, you couldn't rent it to your business
if it's in your self-directed IRA, because then you're also self-dealing.
And that's a prohibited transaction.
So those are four reasons why
you may not want to use a self-directed IRA to invest in real estate.
Now, I'm not saying that you should never invest using a self-directed IRA,
but I am saying that real estate is already incredibly advantageous
from a tax perspective and you really need to consider everything
you're giving up by placing real estate in a self-directed IRA
and what it's going to restrict you from doing in the future.
So I hope this helps and I'll see you guys in the next video.