What are Real Estate Options?

real estate IRA doesn’t have to hold tangible property. The power of self-directed investing lies in your capacity to put almost any strategy to work for your retirement. There are many “subcategories” in the real estate field—long-term rental properties, fix & flips, land speculation, etc.—all of which your self-directed IRA can hold. Real estate options are other seldom-addressed but viable possibilities for retirement investors.

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An options contract gives the holder the right to purchase an asset for a specific price by a specific date. Unlike futures contracts, options are, as the name implies, optional. Upon reaching the contract expiration date, a holder can choose to execute the stipulated transaction.

For example, a self-directed investor may be keen to acquire a $250,000 property that he can’t afford at the moment. He believes it will appreciate to $300,000 in the near future but would prefer not to finance the investment because he’d rather avoid unrelated business income tax (UBIT). Instead, he may purchase a real estate options contract from someone who’s more bearish on real estate:

  • For a $5,000 fee, the seller gives the buyer the option of purchasing the property for $250,000. The buyer may do so at any time over the course of the following year.
  • Let’s say the property appreciates to $275,000 in six months; the buyer still has another six months to act on the contract if he so chooses. However, market conditions have changed and he’s wondering if property values have peaked. He may therefore exercise the option and buy the $275,000 property for only $250,000.
  • He could also sell the contract to another buyer who believes the property value will continue to rise. Ideally, he would sell the contract for a higher fee than the $5,000 he paid. Some investors trade options strictly for the purpose of trying to realize a profit in this manner. As such, self-directed IRA holders with smaller account balances can earn money on real estate without ever laying eyes on a piece of property.
  • The buyer may allow the contract to expire if the value depreciates. In all likelihood, he would not want to pay $250,000 for a property that’s now worth less than that. The seller, who correctly predicted that the property wouldn’t appreciate, would keep the $5,000 contract fee (her incentive for agreeing to the options contract in the first place).

The Bottom Line

This investment model enables you to tap the real estate market without the responsibilities of managing physical property. If you do exercise a contract and obtain property on behalf of your self-directed plan, you will have presumably done so with a chance to profit in the near term. At the very least, you’ll have the flexibility afforded by self-direction to proceed as you see fit. If you don’t exercise an option, you’ll have only paid the contract fee and can move on to other investment opportunities.

It may behoove you to consult with a financial professional before engaging with real estate options, as these assets can be highly speculative. For more information about self-directed retirement, please don’t hesitate to give us a call at 877-742-1270 or send us a message through the Client Portal.

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