A Self-Directed Individual Retirement Account – is an individual retirement account that requires the account owner to make all investment decisions on behalf of the plan. IRS guidelines require that a qualified Trustee / Custodian hold any IRA assets on behalf of the IRA owner.
The trustee or custodian will be responsible for:
- Maintaining the assets
- Recording all transaction and records pertaining to the IRA
- File required IRS reports
- Issue client statements
- Help IRA owner understand the rules and regulations pertaining prohibited transactions
- Other administrative duties as required
The trustee/custodian usually offers standard asset options that the account owner can select to invest in. Often, this selection comprises of traditional stocks, bonds, and mutual funds. However, many will also permit the account owner to make other types of investments permissible by the IRS.
The IRS prohibits a Self Directed IRA owner to invest in life insurance, collectible items such as artwork, antiques, rugs, metals (there are exceptions for certain kinds of bullion), stamps, gems, coins (there are exceptions for certain coins minted by the U.S. Treasury), alcoholic beverages, and other tangible personal property.
Other transactions that are prohibited by the IRS include: borrowing money from the IRA, selling property to it, receiving unreasonable compensation for managing an Investment Retirement Account, using the account as security for a loan, or buying property for personal use (present or future) with IRA funds.
In the case that the owner of an IRA account engaged in a prohibited transaction, the account will be considered in violation of IRS regulations. This will result in the distribution of all account assets to the owner at the current fair market value on the first day of the year in which the prohibited transaction occurred. This distribution of funds is subject to any taxes or penalties associated with early distribution. This usually equates to a 10% early withdrawal penalty and treatment of the distribution as ordinary income for income taxes purposes.
A self directed IRA account owner is permitted under the IRS regulations to invest in transactions such as real estate, stocks, mortgages, franchises, partnerships, private equity and tax liens.
A real estate transaction may include:
- Residential / Commercial properties (U.S. & Internationally),
- Raw land
- New construction
- Property renovation
- Passive rental income
Under the real estate guidelines – a mortgage can be placed against a real estate property that is acquired in a self directed IRA. By doing this a lower out of pocket cash amount needed for the purchased is guaranteed; however, it is important to know that under IRS regulations, both the IRA and IRA account owner are not allowed to have personal liability on the mortgage.
Business investments may include partnerships, joint ventures, and private stock. This type of investments include: funding a start-up business or other for-profit venture that is managed by someone other than the IRA account owner.
Some allowable alternative investments that have not been discussed include: equipment & leases, royalty rights, commodities, commercial paper, foreign stock, hedge funds, American depository receipts, and U.S. T-bill.