People always want the best returns for their money. Many have found real estate to be the ideal investment class. Fortunately, the US government allows a tax-advantaged account to invest in this asset.

The self-directed IRA (otherwise known as the SD-IRA) was introduced in 1974. It allows citizens to invest in real estate and notes, tax lien certificates, precious metals, and private placements. SD-IRA holders must report the investment value annually to their IRA custodian.

If you’re considering setting one up, keep in mind that it is more legwork than a traditional IRA because it’s more complicated. Which custodian you choose is important because they’ll be the one guiding you. The IRS tax code gets complex. Do your homework regarding fees and expenses. Usually, SD-IRA holders set up a limited liability company (LLC) to hold their assets. There are additional legal fees for this.

What’s fantastic about self-directed IRAs is that you gain from tax-deferred income until you start taking withdrawals. Like other tax-advantaged accounts, you must wait until the age of 59.5 or older to withdraw. If you take money out earlier, you’ll be subject to an early withdrawal penalty. This will be taxed as ordinary income (which tends to have a high rate).

If you have no experience in real estate, you will need to be cautious. Since you’re investing, the due diligence is on you. It’s not like plain vanilla IRAs where you can invest in a mutual fund and forget it. You will do things like selecting a property and managing it.

Another concern is the lack of diversification. Real estate is a significant investment and might not create a balanced portfolio. This might be hard to avoid but keep an eye on your allocations.

Although real estate can make a spectacular investment, one drawback will always be the lack of liquidity. While a stock or bond can be sold in seconds, it can take months, if not years, to sell real estate. Ensure you have enough cash in your bank accounts not to need to sell your properties in a hurry. A fire sale would be financially disastrous.

Real estate can make a lucrative investment, in some cases offering significantly higher returns than traditional stocks and bonds . If you have extra retirement capital to put to work, look no further than the self-directed IRA.