Self-Directed IRA

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.

Prohibited asset types

Internal Revenue Code Section 408 prohibits IRA investments in life insurance and in collectibles such as artwork, rugs, antiques, metals (there are exceptions for certain kinds of bullion), gems, stamps, coins (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. In essence, IRA prohibited transactions are transactions that Congress has deemed inappropriate between IRAs and certain people associated to those IRAs. The IRS prohibited transaction rules apply to both Traditional IRA and Roth IRAs. These rules are generally designed to prevent self-dealing transactions, which are transactions that directly or indirectly benefit the IRA holder and not the IRA or plan. Disqualified persons include the IRA holder, a fiduciary (e.g., the IRA holder or plan participant) and members of the IRA holder’s family, such as 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, or trustee);
• 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 examples of 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 the IRA holder 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. The penalty for engaging in an Internal Revenue Code Section 408 prohibited transaction differs from the Internal Revenue Code Section 4975 penalty. If IRA assets are invested in collectibles or life insurance, only the assets used to purchase the investment are considered distributed, not the entire IRA.

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.

Permitted investments

The Internal Revenue Code does not describe what a self-directed IRA can invest in, only what it cannot invest in. Internal Revenue Code Sections 408 & 4975 prohibit Disqualified Persons from engaging in certain types of transactions. Some of the additional investment options permitted under the regulations include real estate, stocks, mortgages, franchises, partnerships, precious metals., private equity and tax liens. Real estate may include residential and commercial properties (U.S. & Internationally), home flipping., 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. This type of mortgage is often referred to as a nonrecourse loan. Note – using a nonrecourse loan for a real estate transaction or margin with a security purchase can trigger a tax since the income would be considered “Unrelated Business Taxable Income tax” (UBIT or UBIT). 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. Note – using a self-directed IRA to invest in an active trade or business via a passthrough entity, such as an LLC or partnership can trigger a tax as the income generated would be treated as UBIT. Other alternative investments include: commodities, hedge funds, commercial paper, foreign stock, royalty rights, equipment & leases, American depository receipts, and U.S. T-bill

Precious metals

A self-directed IRA can also invest in precious metals such as gold, silver, and platinum. The regulations pertaining to investing in precious metals can be found in Section 408(m)(3) of the Internal Revenue Code. Most government minted coins (American Eagles, Australian Nuggets, etc.) are permissible. Bullion is also permissible if it meets a standard level of fineness, and is produced by a COMEX or NYMEX approved refiner. When a retirement account invests in precious metals, the metals are typically held by a third-party custodian. However, there are a limited number of platforms which allow for personally holding gold coins.

Limited liability company structured IRA

In an effort to reduce fees, paperwork, and processing delays, title issues, etc., some self-directed IRA investors choose to employ a Limited Liability Company (LLC) IRA structure. In such a structure the account holder directs his or her IRA custodian to invest into a limited liability company in return for a percentage interest in the LLC that the account owner or a third-party manages himself or herself. The account owner can then execute transactions for the IRA LLC without the involvement of the IRA custodian, thus reducing fees and eliminating custodian transactional fees and delays. Since an LLC is treated as a passthrough entity for Federal Income Tax purposes, the profits of the LLC pass through to the IRA, which is exempt from tax under Internal Revenue Code Section 408 (408A in the case of a Roth IRA). Some claim that this IRA LLC strategy has been legitimized through a tax court case: Swanson v. Commissioner, 106 T.C. 76 (1996) and IRS Field Service Advice Memorandum 200128011, which mirrors the facts and confirms the Tax Court’s conclusion in Swanson. 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.

IRA LLC Law

Although Swanson v. Commissioner doesn't directly relate to a single member IRA LLC, but instead merely sets a precedent that an individual can control an entity owned by an IRA or IRAs that they are a disqualified person to, there are other cases, private letter rulings and IRS Memorandums that corroborate the validity of the IRA LLC and Checkbook Control over an IRA. An IRA LLC is permissible for the same reasons a stock is permissible. In fact, IRA Law doesn't permit any given investment, instead it only prohibits specific "self-dealing" investments and transactions. For more information on IRA LLC law see:

• U.S. Code Title 26 Section 408 and 4975
• Ancira v. Commissioner 119 T.C. No. 6 (2002)- Ancira acted as a conduit for her self-directed IRA custodian
• Swanson v. Commissioner 106 t.c. 76 (1996) - Swanson directed his IRA to invest in a company in which he controlled and was also owned by the IRAs of his 3 children.
• DOL Advisory Opinions 97-23A and 2005-03A - The Department of Labor takes the position that if an asset is owned 100% by a plan, that asset becomes the plan
• IRS Field Service Advice 200128011 - IRS Confirms: "The type of investment that may be held in an IRA is limited only with respect to insurance contracts, under section 408(a)(3), and with respect to certain collectibles, under section 408(m)(1"

See also

• Individual Retirement Account
• 401(k)
• Comparison of 401(k) and IRA accounts
• Roth 401(k)
• 403(b)
• Internal Revenue Service
• Rollovers as Business Start-Ups
• Self-invested personal pension in the United Kingdom

External links

• Self Directed IRA Frequently Asked Questions. Self Directed IRA
• Unlocking the global-trillion dollar crowdfunding market. Huffington Post
• Investing in real estate with a self directed ira. Bloomberg
• New JOBS act will revolutionize retirement. Forbes
• Marino, Vivian (April 17, 2005), "Using an IRA to Buy Real Estate", New York Times 
• Take charge of your IRA. CNNMoney.com