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Most individual retirement accounts (IRAs) limit you to investing in stocks and bonds. However, a self-directed account allows you to allocate a portion of your portfolio to alternative investments such as gold or real estate.
As a general rule, neither gold nor real estate is correlated with the stock market. Therefore, it may be possible to see positive returns on capital even during periods of inflation or political unrest.
However, there are many differences between these two asset classes that you should be aware of before making an investment decision.
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Why Invest in Gold?
Investing in gold may be ideal if you are looking for something that tends to hold its value when the rest of the world is falling into disarray. Gold holds its value because it is a tangible resource, which means that it can be used to facilitate transactions between buyers anywhere in the world.
If a government were to collapse and render its currency worthless, buyers and sellers could revert to gold to complete a transaction as it is a universal store of value.
As it is seen as a safe haven, investors tend to shift their money from currencies to gold during periods of economic or political instability. Therefore, it may be used as a hedge against short-term losses in the stock market.
Furthermore, since it is a tangible asset, gold tends to be bound by traditional concepts such as supply and demand. Ultimately, you'll find that it is less vulnerable to the scourge known as inflation, which means that it is less vulnerable to price bubbles and significant corrections to the downside.
Finally, investing in gold may be ideal if you are looking for a relatively inexpensive way to store and maintain your wealth.
In most cases, you'll only need to pay storage fees and other miscellaneous charges after purchasing gold held in your IRA. However, these fees may be reduced or waived entirely depending on where your gold is kept.
Why Invest in Real Estate?
Investing in real estate may be ideal for those who are looking to create multiple streams of revenue for themselves. For instance, if you own a property that is zoned for both commercial and residential use, you can attract multiple tenants to the same property.
The same may be true if you have a home or apartment building that is built to house multiple tenants. In some cases, it may be possible to rent each bedroom individually while giving all renters access to a common area.
In addition to collecting rent checks, you also benefit from long-term price appreciation. This is especially true in today's market where buyers are gladly spending tens of thousands of dollars over the asking price to acquire residential real estate.
Even if you don't want to sell, price appreciation can provide you with other forms of financial flexibility. For example, you can borrow against your home's equity to purchase additional real estate or to make improvements to the house that will further increase its value. You can also use a home equity loan or line of credit as a means of refinancing credit cards or other types of personal debts.
If you rent to commercial tenants, it may be possible to delegate building maintenance to those tenants. This means that you benefit from any repairs or upgrades made to your property without having to pay for them. Commercial tenants may also be liable for insurance and other costs, which helps to increase your overall return on investment.
Holding Gold Inside of an IRA
There are many rules that you must follow if you wish to hold gold inside your self-directed IRA. For example, you will need to choose a custodian that is responsible for adhering to reporting and other requirements imposed by the IRS. If you fail to adhere to IRS requirements, you may lose the tax advantages associated with a gold IRA.
The primary advantage is that you don't have to pay income taxes until you make withdrawals in retirement. If you have a Roth IRA, you don't have to pay anything at all since contributions are made with after-tax dollars. In addition, you don't have to pay capital gains taxes on items that are sold for a profit within your IRA.
To hold gold inside of an IRA, you will need to make sure that it is 99.5% pure and sourced from a refiner that is certified by NYMEX, COMEX, or another approved entity.
If you have a proof coin, it must be in mint condition, encased in approved packaging, and accompanied by a certificate of authenticity. Nonproof coins must be free from damage as well as be labeled as uncirculated to qualify for inclusion within an IRA.
Examples of proof coins that meet IRS requirements include the American Eagle proof and nonproof coin as well as the Canadian Maple Leaf coin. U.S. Buffalo bullion coins, Australian Kangaroo coins as well as Australian Lunar Series coins comply with these standards.
Holding Real Estate in an IRA
There are several provisions that you must abide by if you decide to hold real estate in an IRA that doesn't apply to a typical real estate portfolio.
Perhaps the biggest difference is that your holdings are owned by the IRA itself. This means that any revenue generated by a residential or commercial property must go back into it instead of into your own pocket.
Furthermore, since the property is owned by the IRA, you can't take any of the potential tax write-offs afforded to most owners. It may also not be possible to obtain a mortgage for any properties held for investment purposes. This means that you'll need to finance 100% of the purchase price, which could limit your potential return on investment.
It may also be difficult or impossible to obtain a HELOC or other lines of credit secured by the equity in a property held by an IRA. Therefore, if you need to make repairs or upgrades to a home or commercial property, the IRA will need to cover those expenses on its own or hope that your tenants take care of them on their own.
If there are insufficient funds in an IRA to cover needed repairs, it may be possible to make a contribution to make up for a possible shortfall. However, the IRS limits contributions to $6,500 in you are under the age of 50 or up to $7,500 a year if you are over age 50.
Exceeding those limits may result in financial penalties or other issues that might negatively impact your return on investment. It's also worth noting that any dollars used to repair real property are dollars that lose out on the ability to compound over time.
Buy and Sell
You are also limited as to who you can buy or sell properties to. For example, you cannot buy properties that you or your family members currently own. In addition, you cannot sell properties held in an IRA to family members or others who may already have a majority ownership stake in a home or commercial building.
Finally, you cannot live in a property owned by your IRA, and your family members and other close associates are also barred from using it for personal or business purposes.
As with other assets held in an IRA, they are exempt from capital gains or other taxes while held in your account. This means that you may avoid paying tens of thousands of dollars whenever you flip or sell a residential or commercial building for profit. An ability to avoid capital gains taxes may offset maintenance and other expenses incurred before the sale.
Liquidity Issues to Consider
As a general rule, gold is more liquid than real estate. Typically, your gold dealer will be happy to purchase bullion, proof coins, or other holdings that you would like to liquidate. In some cases, you may be entitled to a buyback guarantee or some other assurance that you'll get the most for your holdings when it's time to sell.
If you want to sell a home or office building, you may spend weeks or months trying to locate a buyer. It may also take time to negotiate a sale price, inspect the property or take care of other issues a buyer might have. In most cases, a gold sale can be completed in a matter of minutes and at a price that you can look up before engaging in the liquidation process.
Real Estate May Be More Vulnerable to Inflation
Whether you choose to hold real estate in an IRA, in a trust, or in your own name, it tends to be sensitive to inflationary pressures. For example, if interest rates go up, home prices tend to decline.
This is because it costs more to borrow the money needed to buy a home, office building, or plot of land. It also costs more to acquire the materials needed to make improvements to a property. Therefore, buyers may choose to wait until conditions are more favorable to them.
It's not unheard of for property values to decrease by up to 50% during significant economic downturns. While this may provide you with an opportunity to acquire properties for significantly less than they might be worth, it also means lowering your expectations for a quick return on capital.
You may also have trouble demanding rental rates that are much higher than your mortgage or overall carrying costs on a given property.
Are You Good With People?
Another potential upside to investing in gold compared to real estate is that you don't have to worry about finding or managing tenants. As a property owner, you are responsible for ensuring that your home is free of defects and that your tenants are good neighbors.
If anything happens on your property, you may be liable even if you didn't do anything wrong. For instance, if your tenants were selling drugs on your property, you could be cited for being a negligent property owner.
You may also be liable for fixing issues with a home that arise in a timely manner such as a hole in the roof, a burst pipe, or a furnace that stops working without warning.
Although you can hire a property management firm to screen tenants or handle other tasks, those firms can charge hefty fees. This is in addition to the custodial fee that you'll need to pay if you choose to keep real estate in an IRA.
Of course, there is no guarantee that you'll have problem tenants. However, if you don't feel comfortable interacting with people regularly, gold may be the better option.
Instead of worrying about problem tenants causing property damage, you can rest easy knowing your gold is in a secure location managed by your gold dealer.
What Happens After You Die?
There are a few things that happen to an IRA after the account owner passes on. First, it can be transferred to the surviving spouse where assets can continue to grow on a tax-advantaged basis. Alternatively, it could be transferred to a child, friend, or anyone else who isn't your spouse.
In such a scenario, the account either has to be liquidated or labeled as an inherited IRA. If your heir chooses to consider the account as an inherited IRA, that person is immediately subject to the required minimum distributions (RMDs).
This could make it difficult to cover maintenance or other carrying costs associated with real estate held inside of the account. Liquidating real estate on short notice may also prove challenging because of the limitations on who can buy it.
Therefore, if your goal is to keep a property in the family for several generations, it may be best to keep real estate in a trust or outside of an IRA. However, if you're simply looking for a way to secure your child's future, gold may be the way to go as it can easily be sold when it's time to close your account or take an RMD.
Final Thoughts
Investing in both gold and real estate can help to meet your current and long-term financial goals. However, putting money into gold coins or bullion may be ideal for those who are looking for a passive way to grow their retirement accounts or who want a hedge against inflation.
Real estate may be best for those who have a significant amount of cash available and don't mind investing in assets that may be less liquid or that demand active oversight.
Remember to read our list of the Top Gold Companies.
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