What is a Self Directed IRA?

What is a Self Directed IRA is it legal?

A Self-Directed Individual Retirement Account 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

IRS regulations prohibit IRA investments in life insurance and in collectables 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. 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.
Having your IRA purchase real estate that is owned by a family member of lineal descent, such as your father.
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 estate, stocks, 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. 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 Company (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.^[1] 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.

All of which can be advised by your Custodian.

Case Studies

Prohibited Asset Types

Prohibited Transactions

Common Permitted Investments

Limited liability company structured IRA

Case Studies