by Mark Ross, VP and Portfolio Manager, Riverplace Capital, Jacksonville, FL
A self-directed IRA is no different than any other IRA, with the exception that a self-directed IRA simply allows you to direct a wider range of investments such as real estate, tax certificates and even notes. Traditional IRA custodians restrict you only to the investment products that they sell.
What can I invest in if I have a Self-Directed IRA?
The investments that you make outside of your IRA can now be made within it. You the investor have tremendous flexibility to make the investments of your dreams. With a self-directed IRA, Riverplace Capital can show you how to invest your IRA in investments such as:
- Residential Real Estate
- Commercial Real Estate
- Raw Land
- Trust Deeds / Mortgages, and Mortgage Pools
- Private Notes and Loans
- Limited Liability Companies (LLCs)
- Tax Certificates
- And MANY other investments!
What types of retirement accounts can be moved into Self-Directed accounts?
- Traditional IRA’s
- Sep IRA’s
- Roth IRA’s
- Coverdell Education Savings (ESA)
- Qualified Annuities
- Profit Sharing Plans
Are Self-Directed IRA’s new?
No. There are two TRILLION dollars held in retirement accounts; however, only about 3% of retirement accounts are self-directed and only about 2% are invested in Real Estate. Self-directed IRA’s have been allowed since the creation of the IRA approximately 30 years ago.
Why haven’t I heard of Self-Directed IRA’s before?
The traditional investment community consists primarily of banks and stock brokerage companies. They “control” over 97% percent of retirement accounts. As custodians, they only allow products that they sell to be held in IRA accounts held at their institutions.
Can I convert my IRA, Sep IRA, Roth IRA to a Self-Directed IRA and direct investments myself?
Yes. You can convert and self-direct all these types of accounts. In certain circumstances, you can also convert 401k and other employer plans as well.
Can I invest my Self-Directed IRA into Real Estate?
Absolutely. Real Estate is one of the most common non-traditional investments purchased inside of a self-directed IRA. Within the broad category or Real Estate, there are many options for investment to name a few:
- Residential Rentals
- Commercial Properties
- Mobile Homes
- Raw Land
Can my Self-Directed IRA purchase Real Estate I already own?
No. This would be considered a prohibited transaction (see IRC 4975). You many not purchase property which is currently owned by you or any other disqualified person (see below). You would need to find another piece of Real Estate that you don’t already own to purchase.
If I buy an income producing rental property in a Self-Directed IRA, what happens to the rent income?
The income MUST go back into the Self- Directed retirement account.
My Self- Directed IRA is small. Can I personally co-invest with my IRA?
The answer is yes, however, you must be sure this is set up correctly through the creation of an LLC.
Can my Self-Directed IRA co-invest with friends?
Yes. Self-Directed IRA’s may purchase an undivided (and proportionate) interest in Real Estate.
May I use my Self-Directed IRA funds to make improvements or renovations?
Yes. In fact, you must use IRA funds to make the improvements and pay all expenses associated with the property. All expenses of the property are paid with IRA funds, and all income generated from the property must be deposited back into the IRA.
Can I buy vacation property using my Self-Directed IRA?
Yes. Doing so would not constitute a prohibited transaction. However, you cannot vacation there yourself. This would be considered self-dealing.
Can I buy my dream retirement home with my Self-Directed IRA and then live in it when I reach retirement age retirement?
Yes. Your IRA would be the original owner. You would use your IRA money to make the purchase and maintain the property. Any rents generated would be returned to the IRA. However, upon reaching retirement age, the property could be distributed out to you. Of course, you would have to pay taxes at that point, but without penalty if you are over the age of 59 1/2.
Can my Self-Directed IRA get a mortgage on a piece of property?
Yes. The mortgage would need to be a non-recourse type of loan, meaning that if your IRA fails to make the payments, the only recourse the lending institution has is the property itself. Also, be aware that if your IRA obtains a loan, unrelated debt financing income tax will apply.
Can my Self-Directed IRA make loans to other individuals who want to buy Real Estate?
Absolutely. And this is done frequently, and it is a great investment for your IRA because the loan can be secured by the property.
Can I make a loan to my brother or sister so that he can use the money as a down payment on a home?
Yes. According to IRC 4975, siblings are not included in the definition of disqualified persons. Thus, a loan to your brother or sister would not be a prohibited transaction.
Can my Self-Directed IRA make loans to a friend?
Absolutely. Friends are not disqualified persons under the Code, and therefore, your IRA can make a loan to them for any purpose whatsoever (boat, airplane, hot tub, home improvements, etc.). Of course, you want to make sure that there are proper formalities and reasonable terms to the loan.
Do taxes and penalties apply when I take money out of my self-directed IRA to buy Real Estate?
No. You DO NOT take money out to purchase Real Estate. The IRA becomes the owner of the investment. There are no taxes or penalties.
Are the gains taxable which are generated within my Self-Directed IRA?
Not in most cases. If an IRA buys a piece of property and then sells it at a profit, the gains stay within the IRA. If you have a traditional IRA, the gains are tax-deferred. If you have a Roth IRA, the gains are tax free. Note, you alter that result if you use leverage.
Are there any special taxes that apply when I use leverage?
Yes. Unrelated business income tax would apply.
What are Prohibited Transactions within a Self-Directed IRA?
Understanding what constitutes a prohibited transaction is very important when it comes to making investments within your IRA. The IRS defines a prohibited transaction as follows:
“Generally, a prohibited transaction is any improper use of your IRA account or annuity by you, your beneficiary or any disqualified person. Disqualified persons include your fiduciary and members of your family (spouse, ancestor, linear descendant, and any spouse of linear descendant).” IRS Publication 590
IRC 4975 is the section that lays out the rules on prohibited transactions. Prohibited transactions generally involve one of the following: (1) doing business with a disqualified person; (2) benefiting someone other than the IRA; (3) loaning money to a disqualified person; or (4) investing in a prohibited investment.
In plain English, prohibited transactions are those transactions that violate the basic intent of the IRA. Your IRA must benefit rather than benefiting you personally. In other words, there can be no “self-dealing” transactions. However, there are many ways in which you can invest your IRA and not be in violation of the prohibited transaction law. And when your IRA benefits, you benefit because it is for your retirement.
What are Prohibited Investments within a Self-Directed IRA?
The Internal Revenue Code does not specifically authorize investments within an IRA; rather, the code outlines what types of investments are not allowed. The Prohibited Investments include but are not limited to:
Who is a disqualified person regarding a Self-Directed IRA?
- The IRA holder and his or her spouse;
- The IRA holder’s ancestors of lineal descendants and their spouses;
- Investment Advisors
- Anyone providing services to the IRA such as a trustee or custodian.
What would be classified as self-dealing within a Self-Directed IRA?
Self-dealing is using your IRA in transactions that in some way benefit you (or other disqualified persons) individually. The purpose of your IRA is to provide for your retirement. It is not intended to benefit you prior to retirement and distribution of the funds.
What are some types and examples of prohibited or self-dealing within a Self-Directed IRA?
- Self-dealing with a family member (having your IRA purchase a home from your father).
- Self-dealing with yourself (having your IRA purchase a home from yourself).
- Personal use of IRA property (buying a rental vacation home with IRA money and then staying in the home when on vacation).
- Receiving personal benefit from your IRA (paying yourself for work that you do on the property such as repairing the roof).
Can I buy a business with my Self-Directed IRA?
Yes, you can buy a business with your IRA.
Can I invest in an existing business through my Self-Directed IRA?
Yes. This can be done as the purchase of stock or as a loan to the business. You should no longer
Work for the employer. You can usually combine multiple retirement accounts into one.
Can I invest in gold through my Self-Directed IRA?
You can invest in gold! As per the IRA statutes, some types of bullion and gold fall under the category of collectibles and according to the law you cannot hold any collectibles in your IRA. However, there is an exception that applies to certain highly refined bullion provided it is possessed by an IRS-authorized nonbank trustee or an approved bank. This rule is also applicable to indirect acquisitions like using the IRA-owned LLC to purchase the bullion. A reputable precious metals dealer will know the IRS rules.
Can my Self-Directed IRA deduct any losses on my income tax return?
No. This is one of the disadvantages of investing within any retirement account.
If I am a Realtor, can I receive commission for the property that is bought or sold using the funds in my own Self-Directed IRA?
No. This would be considered a prohibited transaction and self-dealing.