Real Estate Options for a Real Estate Investor
As an investor, you have likely heard that investing in real estate can be a great way to build long-term wealth potential. However, as you prepare for retirement, it is important to understand the various types of retirement options that may be available to you as a real estate investor, and how to structure your investments to help manage taxes. In this blog post, we will explore various retirement strategies available and tax strategies that can help you manage your tax liability.
A Traditional IRA (Individual Retirement Account) is a tax-deferred retirement account that allows you to contribute pre-tax dollars up to a certain limit each year. These contributions are tax-deductible, which means that you can lower your taxable income for the year. However, you will have to pay taxes on the money you withdraw in retirement.
As a real estate investor, you can use a Traditional IRA to invest in real estate through a self-directed IRA. With a self-directed IRA, you hold various alternative investment in your portfolio, such as real estate assets which may include rental properties, raw land, or private real estate funds. By using a self-directed IRA to invest in real estate, you can potentially grow your retirement savings tax-free until you withdraw the funds.
A Roth IRA is another type of individual retirement account that offers tax advantages. Unlike a Traditional IRA, contributions to a Roth IRA are made with after-tax dollars. This means that you won’t be able to deduct your contributions from your taxable income, but you will be able to withdraw your funds tax-free in retirement.
As a real estate investor, you can also use a self-directed Roth IRA to hold real estate in your portfolio. With a Roth IRA, you can invest in real estate assets that have the potential to appreciate in value, and you won’t have to pay taxes on any capital gains when you sell the assets.
SIMPLIFIED EMPLOYEE PENSION (SEP) IRA
A Simplified Employee Pension (SEP) IRA is a retirement account that is specifically designed for self-employed individuals and small business owners. With a SEP IRA, you can contribute up to 25% of your net self-employment income or $66,000 (whichever is less) each year.
As a real estate investor, you can use a SEP IRA to invest in real estate through a self-directed IRA but must ensure your custodian will allow it. By doing so, you can potentially reduce your taxable income by contributing pre-tax dollars to your retirement account, and you can grow your retirement savings tax-free until you withdraw the funds.
A Solo 401(k) is another retirement account designed for self-employed individuals and small business owners. With a Solo 401(k), you can contribute up to $61,000 per year (or $73,500 if you are over 50 years old) to your retirement account.
As a real estate investor, provided a solo 401k provider’s plan documents allows for it, you can use a Solo 401(k) to invest in real estate through a self-directed IRA. By doing so, you can potentially reduce your taxable income by contributing pre-tax dollars to your retirement account, and you can grow your retirement savings tax-free until you withdraw the funds.
DEFINED BENEFIT PLAN
A Defined Benefit Plan is a retirement plan that promises a specified monthly benefit as an exact dollar amount in retirement. These plans are typically offered by employers, but as a self-employed individual, you can also set up a Defined Benefit Plan for yourself.
As a real estate investor, you can use a Defined Benefit Plan to invest in real estate through a self-directed IRA. By doing so, you can potentially reduce your taxable income by contributing pre-tax dollars to your retirement account, and you can grow your retirement savings tax-free until you withdraw the funds.
REAL ESTATE LIMITED PARTNERSHIPS (RELPS)
A Real Estate Limited Partnership (RELP) is a type of partnership where investors pool their money together to invest in a real estate project. One of the benefits of investing in a RELP is that the investors can take advantage of the depreciation deductions associated with real estate ownership. These deductions can help to lower the taxable income of the investors, thereby reducing their tax liability.
As a real estate investor, you can invest in a RELP through a self-directed IRA. By doing so, you can potentially reduce your taxable income by investing pre-tax dollars in the partnership, and you can benefit from the depreciation deductions associated with the real estate assets owned by the partnership.
REAL ESTATE INVESTMENT TRUSTS (REITS)
A Real Estate Investment Trust (REIT) is a company that owns and operates income-generating real estate assets such as apartment buildings, shopping centers, and office buildings. REITs are required by law to distribute at least 90% of their taxable income to their shareholders, which means that they may be an attractive option for investors seeking the potential for regular income.
As a real estate investor, you can invest in a REIT through a self-directed IRA. By doing so, you can potentially reduce your taxable income by investing pre-tax dollars in the REIT, and you can benefit from the potential for regular income generated by the real estate assets owned by the REIT.
A 1031 exchange, also known as a like-kind exchange, is a tax-deferred strategy that allows real estate investors to sell a property and use the proceeds to purchase another “like-kind” property, while deferring the payment of capital gains taxes that would otherwise be due upon the sale of the original property.
In a 1031 exchange, the investor must identify the replacement property within 45 days of the sale of the original property and complete the purchase of the replacement property within 180 days of the sale. If these requirements are met, the investor can defer the payment of capital gains taxes until a later date.
To qualify for a 1031 exchange, the properties involved must be of “like-kind,” which means they must be of the same nature or character, regardless of quality or grade. For example, an investor could exchange a rental property for any other real estate, or a raw land or farmland for improved real estate.
There are several types of 1031 exchanges, including simultaneous exchanges, delayed exchanges, and reverse exchanges.
-Simultaneous exchange, the sale of the original property and the purchase of the replacement property occur at the same time.
-Delayed exchange, there is a delay between the sale of the original property and the purchase of the replacement property.
-Reverse exchange, the purchase of the replacement property occurs before the sale of the original property.
It’s important to note that 1031 exchanges are subject to several rules and regulations, and investors must work with a qualified intermediary to ensure that the exchange is structured and executed properly.
Additionally, there are certain limitations and restrictions on the use of 1031 exchanges, and investors should consult with a tax advisor or attorney to determine if a 1031 exchange is appropriate for their specific situation.
1031 EXCHANGE INTO DELAWARE STATUTORY TRUSTS (DSTS)
A DST or Delaware Statutory Trust is a type of legal entity that is commonly used in real estate investing as a way to hold title to a property. In a DST, individual investors can pool their funds to purchase a property, and the DST holds legal title to the property on behalf of the investors. Each investor holds a beneficial interest in the trust and receives potential benefits from the property based on their ownership interest.
DSTs are often used in 1031 exchanges, which allow real estate investors to defer capital gains taxes on the sale of a property by reinvesting the proceeds in another property, which could be a larger property or a portfolio of properties.
It’s important to note that DSTs are regulated by the SEC (Securities and Exchange Commission) and must be structured and offered in compliance with securities laws. Additionally, DSTs have fees and expenses like direct property ownership, and investors should carefully evaluate the costs and risks before utilizing a DST as a 1031 exchange replacement property.
Opportunity Zones are designated areas in the United States that have been identified as being in need of economic development. Investors who utilize Opportunity Zones for their capital gains can benefit from tax incentives, including varying deferral percentages up to full deferral of capital gains taxes on investments held in the Opportunity based on inclusion dates.
As a real estate investor, you can invest in real estate assets located in Opportunity Zones through a self-directed IRA. By doing so, you can potentially reduce your taxable income by investing pre-tax dollars in the real estate assets, and you can benefit from the tax incentives associated with investing in an Opportunity Zone.
In conclusion, there are a variety of retirement strategies available to real estate investors, each with its own tax advantages and disadvantages. By understanding the various retirement strategies available, you can help manage your tax liability while build toward your retirement. As with any investment, it is important to consult with a financial advisor or tax professional before making any investment decisions.
Because investor situations and objectives vary this information is not intended to indicate suitability or a recommendation for any individual investor.
This is for informational purposes only, does not constitute individual investment advice, and should not be relied upon as tax or legal advice. Please consult the appropriate professional regarding your individual circumstance.
IRC Section 1031 is a complex tax concept; consult your legal or tax professional regarding the specifics of your particular situation. This is not a solicitation or an offer to sell any securities.
Potential cash flows/returns/appreciation are not guaranteed and could be lower than anticipated.
There are retirement account risks that could diminish investor returns, such as, but not limited to: low interest rates, market volatility, withdrawal timing and sequence of returns risk, government policy uncertainty and increased longevity. Prospective investors should perform their own due diligence carefully and review the “Risk Factors” section of any prospectus, private placement memorandum or offering circular before considering any investment.
There are material risks associated with investing in private placements, Delaware Statutory Trusts (“DSTs”) and real estate securities including the potential loss of the entire investment principal, illiquidity, tenant vacancies impacting income and revenue, general and real estate market conditions, lack of operating history, interest rate risks, competition, including the risk of new supply coming to market and softening rental rates, general risks of owning/operating commercial and multifamily properties, short term leases associated with multi-family properties, financing risks, potential adverse tax consequences, general economic risks, development risks, long hold periods, and investors should read the PPM carefully before investing paying special attention to the risk section.
DST 1031 properties are only available to accredited investors (typically have a $1 million net worth excluding primary residence or $200,000 income individually/$300,000 jointly of the last three years) and accredited entities only. If you are unsure if you are an accredited investor and/or an accredited entity please verify with your CPA and Attorney.
Certain Qualified Opportunity Zone (QOZ) areas may not be able to appreciate as predictably as more established areas. Some neighborhoods may be more accommodating to development than others, impacting the success of the investment. Development and redevelopment of real estate traditionally have more risk than other types of real estate strategies. The availability and cost of construction and development financing is uncertain and represents a risk inherent in the execution of a QOF strategy. The rules and regulations of the QOZ Program are complex, compliance with the QOZ Program comes with significant challenges. QOFs tend to be illiquid investments for ten or more years. Any discussion regarding “Qualified Opportunity Zones” — including the viability of recycling proceeds from a sale or buyout — is based on advice received regarding the interpretation of provisions of the Tax Cut and Jobs Act of 2017 (the “Jobs Act”) and relevant guidance’s, including, among other things, two sets of proposed regulations and the final regulations issued by the IRS and Treasury Department in December of 2019. A number of unanswered questions still exist, and various uncertainties remain as to the interpretation of the Jobs Act and the rules related to Opportunity Zones investments. We cannot predict what impact, if any.
Investment advisory services offered through Bangerter Financial Services, Inc. A state Registered Investment Advisor. Registered Representative and securities offered through Concorde Investment Services, Inc. (CIS), member FINRA/SIPC. Bangerter Financial Services, Inc. is independent of CIS.