The assets of a typical Individual Retirement Account (IRA) are usually limited to investments in equities such as corporation stocks and are overseen by a commercial bank. However, did you know that you could construct a Self-Directed IRA that may hold assets in a wide variety of investments? The IRS rules on Self Directed IRAs allow investors wide latitude to build retirement wealth and many investors have conjured creative vehicles for Self Directed IRA investments.
Before delving into the various ways people use an Self Directed IRA, it should be emphasized that there are a number of IRS regulations governing their investment. The two most basic are:

  • – No Self-Dealing
  • – No Commingling of Assets

 

Assets of a Self Directed IRA must be separate from one’s personal wealth and investments. For example, should you happen to be a majority owner or a corporate officer of a business, you are not allowed to include the business in your Self Directed IRA. If your Self Directed IRA is invested in a vacation home, it is not allowed to be utilized for your personal use.
Since you are serving as the fiduciary of your Self Directed IRA, you are required by law to follow regulations ensuring that the retirement account stands apart from investments subject to yearly capital gains taxation. This includes not borrowing money from an Self Directed IRA or using the account as collateral for loans. Personal funds must be clearly separated from those of the Self Directed IRA – hence, the account must pay all operating costs, taxes and maintenance fees from accrued revenue. A Self Directed IRA cannot buy or sell investments from the fiduciary (you) and cannot receive “unreasonable” compensation for overseeing the account.

The IRS also prohibits a Self Directed IRA fiduciary from dealing with “disqualified persons.” A disqualified person, directly or indirectly, cannot buy, sell, exchange or lease property to the fiduciary. Nor can they loan money or offer credit. Disqualified people cannot furnish goods, facilities or services and they cannot utilize the Self Directed IRA income and assets in any manner whatever. Disqualified people are spouses, children, parents and grandparents/great grandparents (similarly, grandchildren/great grandchildren). Exempt from this rule are the siblings, cousins and aunts/uncles of a Self Directed IRA fiduciary, as they are not in your vertical bloodline.

Prohibited Self Directed IRA Investments

 

  • – S-Corporation Stock
  • – Insurance Contracts
  • – Collectibles including artwork, stamps and antiques
  • – Gemstones or Precious Metals except for most bullion grade gold, silver, palladium and platinum coins and bars

 

IRC Section 4975 for a complete list of prohibited transactions and IRS Publication 590 for a complete list of prohibited investments.

According to the Security and Exchange Commission (SEC) in 2012, 2% of all individual retirement accounts are Self Directed IRAs, encompassing approximately $100 billion in assets. And they cover all sorts of investments, many of which are “outside the box.” Consider, for example, a Palm Beach, FL financial adviser who used an Self Directed IRA as a vehicle to invest in a Las Vegas-based rock ‘n’ roll fantasy camp that connects wannabe rock stars with real life musicians like Roger Daltrey, Jon Bon Jovi and Dave Navarro. The return on the financial adviser’s private partnership share is slated to yield 12-15% annually during its expected five-year run.

Of course, you may choose a more conventional investment option; many people are buying into rental properties and self-storage facilities. The point to be made is that the investor needs to know his playbook – it’s called a self directed IRA because you as the fiduciary call the shots. This latitude is attractive to many people who, during the stock market meltdown of 2008-09, suffered catastrophic losses in their job-related 401(k) administered by trustees who didn’t properly diversify their market basket or were too slow to react to market dynamics. If you’re not confident in your abilities to oversee your Self Directed IRA, you can consult those with the proper expertise to investigate your investment. However, remember hired guns will increase the account’s maintenance fees and must be paid from the revenue generated by the Self Directed IRA.

Speaking of which, many Self Directed IRA custodians or trustees charge much higher maintenance fees than those in traditional accounts. Some feel that this added cost isn’t beneficial to the investor, as by law trustees are not allowed to make investment suggestions or offer investment vehicles. However, there are investment vehicles known as IRA LLCs, which give you the benefit of avoiding unnecessary nickel and dime fees charged by custodians while being able to take even further advantage of flexibility and other investment possibilities. These LLCs are specifically designed to be owned by IRAs, and controlled by the IRA participant. These accounts are able to be set up at a local bank of the participants choice, where they can literally write checks directly from the account to make their transactions, thus eliminating the middle man’s (custodians) processing fees, all of which is completely allowed under IRA law. There are however a limited amount of custodians who allow these structures to be put in place, and you need to find what’s called an IRA LLC facilitator to create, process, and finalize this investment vehicle. Also realize that most commercial banks and brokers will not serve as a trustee of a Self Directed IRA. This is a list of “Non-bank Trustees” (or NBTs) approved by the IRS as of August 1, 2013.

The trustee exists to perform administrative duties such as required IRS paperwork, maintaining transactions and other financial records (including client statements) and explaining to the client the regulatory climate as it pertains to the Self Directed IRA. This last provision can be particularly important, especially if the investor is delving into real estate. For example, you may decide to buy real estate for your Self Directed IRA but if you need to borrow money to close the deal, you or an adviser need to know IRS regulations regarding unrelated business income.

As we say, you need to know your playbook, not only for your Self Directed IRA to make money but to keep in compliance with IRS rules. Should the account owner or the beneficiary of a Self Directed IRA make a prohibited transaction one’s IRA would lose tax exempt status and the fair market value of the IRA would be treated as taxable distribution, which is subject to ordinary income tax. The IRA holder or beneficiary would also be subject to a 15% penalty and a 10% early distribution penalty if the IRA holder or beneficiary is under the age of 59 ½.

Examples of alternative investments for Self Directed IRAs

 

Private Stock Offerings and Private Placements Foreign Currencies Trading Accounts (FOREX)
Private Limited Partnerships, Limited Liability Companies and C Corporations Managed Futures
Hedge Funds Oil & Gas Investments
Gold, Silver, Platinum & Palladium Bullion of Sufficient Fineness or Purity Auto Finance Notes
Residential & Commercial Real Estate Equipment Leasing
Undeveloped Land Publicly Traded Equities (Stocks, Bonds & Mutual Funds)
Real Estate Notes (Mortgages and Deeds of Trust) Factoring Investments