A Self-Directed IRA (Individual Retirement Account) is a type of retirement account that allows the account owner to choose a broader range of investments than traditional IRAs. These investments can include real estate, private mortgages, private company stock, oil and gas partnerships, precious metals, digital assets, horses, livestock, and intellectual property. Due to the increased variety of investments, the U.S. Securities and Exchange Commission (SEC) issued a warning in 2011 about the higher risk of fraud associated with these accounts.
Custodians and Trustees
Internal Revenue Service (IRS) rules require a qualified trustee or custodian to hold the assets in a Self-Directed IRA. The trustee or custodian is responsible for managing the assets, processing transactions, maintaining records, filing required reports, issuing statements, and helping clients understand the rules. They perform these administrative tasks on behalf of the Self-Directed IRA owner.
Investment Options
Unlike regular IRAs, which typically offer stocks, bonds, and mutual funds, a Self-Directed IRA provides access to a much wider range of investment options. This includes real estate, stocks, mortgages, franchises, partnerships, precious metals, private equity, and tax liens. The IRS does not specify allowed investments but does prohibit certain transactions and assets. For example, investments in life insurance and collectibles (such as artwork, gems, or stamps) are not allowed.
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Real Estate Investments
A Self-Directed IRA can invest in any type of real estate if the IRA provider supports real estate investments. If the IRA does not have enough cash to purchase a property, it can partner with other entities or secure a non-recourse loan. All expenses related to the property, such as taxes and maintenance, must be paid from the IRA. The property cannot be used by the IRA owner or disqualified persons. Any income generated from the property must return to the IRA.
Business Investments
Self-Directed IRAs can invest in private companies, including start-ups or for-profit ventures managed by others. However, the IRA cannot own stock in a company where the IRA owner is already a shareholder. Earnings from such investments might be subject to unrelated business income tax (UBIT). The IRA cannot be a general partner in a limited partnership or invest in an S-corporation, as this would invalidate the S-corporation’s tax status.
Precious Metals
Self-Directed IRAs can hold precious metals, which must be kept by a third-party custodian. Acceptable metals include certain gold, silver, and platinum coins, as well as bullion produced by approved refiners. The metals must meet specific purity standards and not be classified as collectibles.
Loans and Other Investments
Self-Directed IRAs can issue loans, with the IRA owner setting the loan terms. The IRA can also invest based on the owner’s expertise, often including real estate and cryptocurrencies.
Prohibited Transactions
The IRS prohibits certain transactions to prevent misuse of the IRA funds. This includes transactions that provide direct or indirect benefits to the account owner or related persons. Violations can result in the IRA being treated as a distribution, subject to taxes and penalties.
Checkbook Control
“Checkbook control” refers to a strategy where the IRA holder establishes a limited liability company (LLC) with the IRA as the sole investor. The holder then manages investments through this LLC, with the IRA custodian handling only contributions and distributions. Although challenged by the IRS, this arrangement was upheld by the U.S. Tax Court in Swanson v. Commissioner (1996).
Conclusion
A Self-Directed IRA offers a diverse range of investment opportunities beyond traditional options. However, it also involves complex rules and higher risks, including potential fraud and prohibited transactions. Careful management and understanding of regulations are essential for successfully using a Self-Directed IRA.
