Self-Directed IRA
Encyclopedia
A Self-Directed Individual Retirement Arrangement is an IRA that requires the account owner to make investment decisions and investments on behalf of the retirement plan. IRS regulations require that either a qualified trustee
, or custodian hold the IRA assets on behalf of the IRA owner. Generally the trustee/custodian will maintain the assets and all transaction and other records pertaining to them, file required IRS reports, issue client statements, assist in helping clients understand the rules and regulations pertaining to certain prohibited transactions, and perform other administrative duties on behalf of the Self-directed IRA owner for the life of the IRA account. The custodian usually offers a selection of standard asset types that the account owner can select to invest in, such as stocks
, bonds
, and mutual funds. In addition, most custodians will also permit the account owner to make other types of investments. The range of permissible investments is broad, however, the IRS does place limits on the types of assets that may be invested in and on the types of transactions that may be carried out.
and in collectibles such as artwork
, rugs
, antiques
, metals (there are exceptions for certain kinds of bullion), gems
, stamp
s, coins
(there are exceptions for certain coins minted by the U.S. Treasury), alcoholic beverages, and certain other tangible personal property.
The following are prohibited transactions with an IRA:
If the account owner or beneficiary engaged in a prohibited transaction, the account is treated as distributing all its assets to you at their fair market values on the first day of the year in which the transaction occurred. The distribution would be subject to any taxes or penalties associated with an early distribution. Generally, a 10% early withdrawal penalty and treatment of the distribution as ordinary income for the purposes of income taxes.
Examples of self-dealing include:
, stock
s, mortgages, franchises
, partnerships, private equity
and tax liens.
Real estate may include residential and commercial properties (U.S. & Internationally), farmland, raw land, new construction, property renovation, development, and passive rental income. Real estate purchased in a self-directed IRA can have a mortgage placed against the property, thus lowering the amount of total cash needed for a purchase; however, neither the IRA nor the account owner of the IRA can have personal liability on the mortgage.
Business investments may include partnerships, joint ventures, and private stock. This can be a platform to fund a start-up business or other for-profit venture that is managed by someone other than the account owner of the IRA. Other alternative investments include: commodities, hedge funds, commercial paper, foreign stock, royalty rights, equipment & leases, American depository receipts, and U.S. T-bill
(LLC) IRA structure. In such a structure the account holder directs his IRA custodian to invest into a limited liability company that the account owner manages himself. The account owner can then execute transactions on the LLC level without the involvement of the IRA custodian, thus reducing fees and eliminating custodian transactional fees and delays. The profits of the LLC pass through to the IRA with nearly identical tax favorable treatment. Some claim that this IRA LLC strategy has been legitimized through a tax court case: Swanson v. Commissioner, 106 T.C. 76 (1996). Others disagree on the validity of the court case. Some refer to this structure as "checkbook control" because the IRA account holder often has sole signing authority for the LLC and its bank accounts.
Trustee
Trustee is a legal term which, in its broadest sense, can refer to any person who holds property, authority, or a position of trust or responsibility for the benefit of another...
, or custodian hold the IRA assets on behalf of the IRA owner. Generally the trustee/custodian will maintain the assets and all transaction and other records pertaining to them, file required IRS reports, issue client statements, assist in helping clients understand the rules and regulations pertaining to certain prohibited transactions, and perform other administrative duties on behalf of the Self-directed IRA owner for the life of the IRA account. The custodian usually offers a selection of standard asset types that the account owner can select to invest in, such as stocks
Stocks
Stocks are devices used in the medieval and colonial American times as a form of physical punishment involving public humiliation. The stocks partially immobilized its victims and they were often exposed in a public place such as the site of a market to the scorn of those who passed by...
, bonds
Bond (finance)
In finance, a bond is a debt security, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest to use and/or to repay the principal at a later date, termed maturity...
, and mutual funds. In addition, most custodians will also permit the account owner to make other types of investments. The range of permissible investments is broad, however, the IRS does place limits on the types of assets that may be invested in and on the types of transactions that may be carried out.
Prohibited Asset Types
IRS regulations prohibit IRA investments in life insuranceLife insurance
Life insurance is a contract between an insurance policy holder and an insurer, where the insurer promises to pay a designated beneficiary a sum of money upon the death of the insured person. Depending on the contract, other events such as terminal illness or critical illness may also trigger...
and in collectibles such as artwork
Work of art
A work of art, artwork, art piece, or art object is an aesthetic item or artistic creation.The term "a work of art" can apply to:*an example of fine art, such as a painting or sculpture*a fine work of architecture or landscape design...
, rugs
Carpet
A carpet is a textile floor covering consisting of an upper layer of "pile" attached to a backing. The pile is generally either made from wool or a manmade fibre such as polypropylene,nylon or polyester and usually consists of twisted tufts which are often heat-treated to maintain their...
, antiques
Antiques
An antique is an old collectible item. It is collected or desirable because of its age , beauty, rarity, condition, utility, personal emotional connection, and/or other unique features...
, metals (there are exceptions for certain kinds of bullion), gems
Gemstone
A gemstone or gem is a piece of mineral, which, in cut and polished form, is used to make jewelry or other adornments...
, stamp
Postage stamp
A postage stamp is a small piece of paper that is purchased and displayed on an item of mail as evidence of payment of postage. Typically, stamps are made from special paper, with a national designation and denomination on the face, and a gum adhesive on the reverse side...
s, coins
COinS
ContextObjects in Spans, commonly abbreviated COinS, is a method to embed bibliographic metadata in the HTML code of web pages. This allows bibliographic software to publish machine-readable bibliographic items and client reference management software to retrieve bibliographic metadata. The...
(there are exceptions for certain coins minted by the U.S. Treasury), alcoholic beverages, and certain other tangible personal property.
Prohibited Transactions
IRS regulations prohibit transactions that are an improper use of the value in the account or annuity by the account owner, the account owner's beneficiary, or any other disqualified person. These rules are generally designed to prevent self-dealing. Disqualified persons include your fiduciary and members of your family, such your spouse, ancestor, lineal descendant (e.g. children), and any spouse of a lineal descendant). In addition, other disqualified persons include:- Service providers of the IRA (e.g., custodian, CPA, financial planner);
- An entity (such as a corporation, partnership, limited liability company, trust or estate) of which 50% or more is owned directly or indirectly or held by a fiduciary or service provider;
- An entity that is a 10% or more partner or joint venturer of with an entity that is 50% or more owned directly or indirectly or held by a fiduciary or service provider;
- Additionally, in the case of a SEP or SIMPLE IRA:
- The Employer;
- 50% or more owner of the Employer;
- Officers, directors, 10% or more shareholders, and highly compensated employees of the Employer;
- An entity 50% or more owned by the Employer;
- 10% or more partner or joint venturer of the Employer.
The following are prohibited transactions with an IRA:
- Borrowing money from it.
- Selling property to it.
- Receiving unreasonable compensation for managing it.
- Using it as security for a loan.
- Buying property for personal use (present or future) with IRA funds.
If the account owner or beneficiary engaged in a prohibited transaction, the account is treated as distributing all its assets to you at their fair market values on the first day of the year in which the transaction occurred. The distribution would be subject to any taxes or penalties associated with an early distribution. Generally, a 10% early withdrawal penalty and treatment of the distribution as ordinary income for the purposes of income taxes.
Examples of self-dealing include:
- Having your IRA purchase real estate that you own or use.
- Issuing a mortgage on a relative’s new residence purchased by a family member who is a disqualified person as listed above.
- Granting a child a second mortgage for the down payment on his or her first home.
- Buying stock from the account owner involving IRA funds and a disqualified person.
- Purchasing stock in a closely held corporation in which the account owner has a controlling equity position.
- Purchasing restricted stock from a family member who is a disqualified person listed above.
Common Permitted Investments
Some of the additional investment options permitted under the regulations include real estateReal estate
In general use, esp. North American, 'real estate' is taken to mean "Property consisting of land and the buildings on it, along with its natural resources such as crops, minerals, or water; immovable property of this nature; an interest vested in this; an item of real property; buildings or...
, stock
Stock
The capital stock of a business entity represents the original capital paid into or invested in the business by its founders. It serves as a security for the creditors of a business since it cannot be withdrawn to the detriment of the creditors...
s, mortgages, franchises
Franchising
Franchising is the practice of using another firm's successful business model. The word 'franchise' is of anglo-French derivation - from franc- meaning free, and is used both as a noun and as a verb....
, partnerships, private equity
Private equity
Private equity, in finance, is an asset class consisting of equity securities in operating companies that are not publicly traded on a stock exchange....
and tax liens.
Real estate may include residential and commercial properties (U.S. & Internationally), farmland, raw land, new construction, property renovation, development, and passive rental income. Real estate purchased in a self-directed IRA can have a mortgage placed against the property, thus lowering the amount of total cash needed for a purchase; however, neither the IRA nor the account owner of the IRA can have personal liability on the mortgage.
Business investments may include partnerships, joint ventures, and private stock. This can be a platform to fund a start-up business or other for-profit venture that is managed by someone other than the account owner of the IRA. Other alternative investments include: commodities, hedge funds, commercial paper, foreign stock, royalty rights, equipment & leases, American depository receipts, and U.S. T-bill
Limited liability company structured IRA
In an effort to reduce fees, paperwork, and processing delays, some self-directed IRA investors choose to employ a Limited Liability CompanyLimited liability company
A limited liability company is a flexible form of enterprise that blends elements of partnership and corporate structures. It is a legal form of company that provides limited liability to its owners in the vast majority of United States jurisdictions...
(LLC) IRA structure. In such a structure the account holder directs his IRA custodian to invest into a limited liability company that the account owner manages himself. The account owner can then execute transactions on the LLC level without the involvement of the IRA custodian, thus reducing fees and eliminating custodian transactional fees and delays. The profits of the LLC pass through to the IRA with nearly identical tax favorable treatment. Some claim that this IRA LLC strategy has been legitimized through a tax court case: Swanson v. Commissioner, 106 T.C. 76 (1996). Others disagree on the validity of the court case. Some refer to this structure as "checkbook control" because the IRA account holder often has sole signing authority for the LLC and its bank accounts.
See also
- Individual Retirement AccountIndividual Retirement AccountAn individual retirement arrangement is the blanket term for a form of retirement plan that provides tax advantages for retirement savings in the United States...
- 401(k)401(k)A 401 is a type of retirement savings account in the United States, which takes its name from subsection of the Internal Revenue Code . A contributor can begin to withdraw funds after reaching the age of 59 1/2 years...
- 401(k) versus IRA comparison matrix401(k) IRA matrixThis is a comparison between 401, Roth 401, and Traditional Individual Retirement Account and Roth Individual Retirement Account accounts, four different types of retirement savings vehicles that are common in the United States.-Comparison:...
- Roth 401(k)Roth 401(k)The Roth 401 is a type of retirement savings plan. It was authorized by the United States Congress under the Internal Revenue Code, section 402A, and represents a unique combination of features of the Roth IRA and a traditional 401 plan. As of January 1, 2006 U.S...
- 403(b)403(b)A 403 plan, also known as a tax-sheltered annuity, is a tax-advantaged retirement savings plan available for public education organizations, some non-profit employers , cooperative hospital service organizations, and self-employed ministers in the United States...
- Individual Retirement AccountIndividual Retirement AccountAn individual retirement arrangement is the blanket term for a form of retirement plan that provides tax advantages for retirement savings in the United States...
- Internal Revenue ServiceInternal Revenue ServiceThe Internal Revenue Service is the revenue service of the United States federal government. The agency is a bureau of the Department of the Treasury, and is under the immediate direction of the Commissioner of Internal Revenue...
- Rollovers as Business Start-UpsRollovers as Business Start-UpsROBS is an arrangement in which prospective business owners use their 401 k retirement funds to pay for new business start-up costs. ROBS is an acronym from the United States Internal Revenue Service for the IRS ROBS Rollovers as Business Start-Ups Compliance Project.ROBS plans, while not...