There are different types of real estate investments to choose from, and one that’s becoming increasingly popular is a real estate investment trust (REIT). If you’re considering investing in real estate through your individual retirement account (IRA), you may wonder if a REIT is the right choice. This blog post will discuss the benefits and risks of investing in a REIT and help you decide if it’s the right move for your IRA.
What Is a REIT?
A REIT is a company that owns or operates income-producing real estate. Its purpose is to generate shareholder value through the acquisition, ownership, management and development of such assets. Explore the three types of REITs below.
1. Equity REITs
There are three types of equity REITs — publicly traded, non-traded and private REITs. Publicly traded REITs are listed on major exchanges, such as the New York Stock Exchange (NYSE). The valuation changes daily and reflects the current market. Publicly traded REITs must distribute at least 90% of their taxable income to shareholders as dividends.
Non-traded and private REITs are not listed on the public market, but non-traded REITs must still be registered with the United States Securities and Exchange Commission (SEC). Non-traded REITs are usually sold through broker-dealers and follow the same reporting requirements and regulations as publicly traded REITs.
Private REITs are not regulated by the SEC and are not subject to the same disclosure requirements as publicly and non-traded REITs but must comply with Regulation D. They are also primarily sold by broker-dealers.
2. Mortgage REITs
Mortgage REITs involve investing in loans secured by real estate. In other words, they allow investors to finance income-producing real estate by purchasing mortgages or mortgage-backed securities (MBS) and earning income from the interest. Mortgage REITs are usually listed on major stock exchanges like public stock but can also be purchased in a mutual fund or exchange-traded fund (ETF). They can generate relatively high dividends.
3. Hybrid REITs
These REITs combine the investment strategies of equity and mortgage REITs. They allow investors to invest in both property assets and mortgages, serving as flexible and robust investment vehicles. Typically, Hybrid REITs are weighted to one investment type or the other and must follow the rules related to those with which they are closely associated.
What Is an IRA?
An IRA is a savings account that allows you to save money for retirement while providing some tax benefits. The tax advantage depends on the IRA type and can either offer tax-deferred or tax-free growth. Standard IRAs are held at banks and brokerage firms and are limited to conventional assets like stocks, bonds and mutual funds. However, you can choose a self-directed IRA, which gives you greater control and has more investment options.
How Does a REIT in an IRA Work?
As mentioned, you can invest in REITs through your self-directed IRA and enjoy tax benefits, depending on the type of IRA. Here are two examples:
- REIT in traditional IRA: This option allows you to deduct contributions from your taxable income. Your investment grows tax-deferred until you take a distribution or withdraw in retirement.
- REIT in Roth IRA: With this IRA type, you do not deduct contributions, but the investment grows tax-free. This arrangement allows you to take distributions or withdraw funds in retirement without paying taxes.
Each type of IRA has unique rules in terms of contribution limits and qualified withdrawals. Thus, you should consult a financial adviser to help you determine which best suits your needs.
IRS Rules for Investing Retirement Income in REITs
The IRS has rules governing investments in REITs through IRAs. The rules generally depend on the type of IRA and include the following:
- Annual contribution limits: The IRS sets annual contribution limits for IRAs, which generally apply to REITs, too. The limits take into account factors like income, filing status and age.
- Tax treatment: Dividends received from REITs are tax-deferred or tax-free, depending on the IRA type. The same applies to capital gains when you sell REIT assets.
- Prohibited transactions: The IRS has strict rules regarding prohibited transactions, which also apply to REIT investments. Violating these rules could lead to penalties or disqualification from the IRA.
- Withdrawal rules: Withdrawals from IRAs are subject to specific rules, depending on the IRA type. Generally, the rules determine when you can or must make distributions and sanctions for noncompliance.
Learning the IRS’s rules allows you to reduce your taxes while ensuring regulation adherence.
Benefits of Investing in REITs Through IRAs
Investing in REITs through your IRA provides many advantages, such as:
- Diversification: REIT investments through IRAs allow you to get exposure to the real estate market without investing directly in property. This strategy can help investors reduce their overall risk. It also expands your options, considering most retirement accounts are full of the standard investments of mutual funds, stocks, ETFs and bonds.
- Steady income stream: IRA REIT investments can generate steady passive income, which is money earned without working. This can be a significant benefit for investors looking for a hands-off investment.
- Tax advantages: The IRA component in REIT investment provides tax benefits. You can either get tax-deferred or tax-free growth, depending on which IRA type you prefer.
- Liquidity: One commonly asked question is, are REITs liquid? The answer is yes, mainly when publicly traded. These REITs can be bought and sold quickly on stock exchanges, making them highly attractive for investors who may need to access their capital while in retirement.
Potential Risks of Investing in REITs
There are some potential risks associated with REITs, including the following:
- Economic cycles: The performance of REITs is closely tied to the economy. When the economy is doing well, they tend to perform well. However, when the economy is struggling, they may underperform.
- Interest rate risk: REITs are also sensitive to changes in interest rates. When interest rates rise, the cost of borrowing for REITs usually increases, which can eat into profits.
- Liquidity concerns: Besides publicly traded REITs, the rest can be challenging to buy and sell. This phenomenon can create issues when you need money urgently.
You can best navigate these hurdles by assessing your needs and choosing the investment options that align with your goals. The financial professionals at Accuplan Benefits Services can help you make informed decisions.
How to Use a Self-Directed IRA for REITs
Investing in REITs is a relatively simple process. Below is a step-by-step guide:
How To Set Up a Self-Directed IRA
You can open a self-directed IRA by following these steps:
- Gather the relevant information, including your social security number and contact details.
- Determine which IRA type you prefer for tax purposes.
- Visit the Accuplan Benefits Services website and create an account by completing the digital form.
- Fund your account by making direct contributions, rolling over an established tax-qualified account or transferring assets or funds from another provider within the same retirement account type.
- Fill out a Direction of Investment form to start your investment.
How to Buy REITs Within Your IRA
Below are the steps for buying REITs with your IRA:
- Determine which REIT type you want to invest in according to your investment objectives.
- Use the funds in your IRA to invest in the preferred REIT.
With so many different choices, it’s essential to do your research before deciding. The team at Accuplan Benefits Services is always ready to help.
Tips for Choosing and Investing in REITs
Here are three best practices when investing in REITs:
- Assess REIT performance: Evaluate the REIT’s performance using key metrics. You should assess the average dividend yield, funds from operations (FFO) and the net asset value (NAV).
- Develop an investment strategy: Determine your long-term and short-term goals before choosing a REIT type. If you are thinking short-term, you may want to consider an option with high liquidity, like a publicly traded REIT. The option you choose will also depend on your risk tolerance.
- Diversifying REIT portfolio: Consider spreading your investment across the different REIT types. This strategy can lower your risks, but it is crucial to obtain financial advice.
REITs are often a great way to get exposure to the real estate market but you must research and understand the risk involved before investing. As a pro tip, consider partnering with a trusted provider for self-directed IRA administration to guide you through the process.
Learn More From Accuplan Benefits Services
Want to start investing in things other than the traditional IRA options like stocks, exchange-traded funds and bonds? With a self-directed account, you can invest in the non-traditional. You can choose from many investments that fit into any budget, including REITS, loans, private equity, gold and silver and cryptocurrencies. These are typically allowed as long as they meet all IRS guidelines for investing. Our experienced team can answer your questions and provide the support you need.
Contact us now to learn more!
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*Our information shouldn’t be relied upon for investment advice but simply for information and educational purposes only. It is not intended to provide, nor should it be relied upon for accounting, legal, tax or investment advice.