self-directed IRA
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A self-directed individual retirement account is an
individual retirement account An individual retirement account (IRA) in the United States is a form of pension provided by many financial institutions that provides tax advantages for retirement savings. It is a trust that holds investment assets purchased with a taxpayer's e ...
(IRA) which allows
alternative investments An alternative investment, also known as an alternative asset or alternative investment fund (AIF), is an investment in any asset class excluding stocks, bonds, and cash. The term is a relatively loose one and includes tangible assets such a ...
for retirement savings. Some examples of these alternative investments are real estate, private mortgages, private company stock, oil and gas
limited partnership A limited partnership (LP) is a form of partnership similar to a general partnership except that while a general partnership must have at least two general partners (GPs), a limited partnership must have at least one GP and at least one limited ...
s, precious metals, digital assets, horses and livestock, and intellectual property. The increased investment options available in self-directed IRAs prompted the SEC to issue a public notice in 2011 due an increased risk of fraud in alternative assets.
Internal Revenue Service The Internal Revenue Service (IRS) is the revenue service for the United States federal government, which is responsible for collecting U.S. federal taxes and administering the Internal Revenue Code, the main body of the federal statutory t ...
(IRS) regulations require that a qualified trustee or custodian hold IRA assets on behalf of the IRA owner. The trustee/custodian provides custody of the assets, processes all transactions, maintains other records pertaining to them, files required IRS reports, issues client statements, helps clients understand the rules and regulations pertaining to certain prohibited transactions, and performs other administrative duties on behalf of the self-directed IRA owner. The account owner of all IRAs chooses among the investment options allowed by the IRA custodian. For regular IRAs, these options typically include
stock In finance, stock (also capital stock) consists of all the shares by which ownership of a corporation or company is divided.Longman Business English Dictionary: "stock - ''especially AmE'' one of the shares into which ownership of a compan ...
s, bonds, and
mutual funds A mutual fund is a professionally managed investment fund that pools money from many investors to purchase securities. The term is typically used in the United States, Canada, and India, while similar structures across the globe include the SICAV ...
, but with a self-directed IRA, the term "self-directed" refers to the significantly broader range of alternative investments available to the account owner. IRA custodians are allowed to restrict the types of assets they will handle in addition to
Internal Revenue Code The Internal Revenue Code (IRC), formally the Internal Revenue Code of 1986, is the domestic portion of federal statutory tax law in the United States, published in various volumes of the United States Statutes at Large, and separately as Title 2 ...
(IRC) restrictions.


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 and 4975 prohibit disqualified persons from engaging in certain types of transactions. Some of the investment options permitted under the regulations include
real estate Real estate is property consisting of land and the buildings on it, along with its natural resources such as crops, minerals or water; immovable property of this nature; an interest vested in this (also) an item of real property, (more genera ...
,
stock In finance, stock (also capital stock) consists of all the shares by which ownership of a corporation or company is divided.Longman Business English Dictionary: "stock - ''especially AmE'' one of the shares into which ownership of a compan ...
s,
mortgages A mortgage loan or simply mortgage (), in civil law jurisdicions known also as a hypothec loan, is a loan used either by purchasers of real property to raise funds to buy real estate, or by existing property owners to raise funds for any ...
,
franchises Franchise may refer to: Business and law * Franchising, a business method that involves licensing of trademarks and methods of doing business to franchisees * Franchise, a privilege to operate a type of business such as a cable television ...
,
partnerships A partnership is an arrangement where parties, known as business partners, agree to cooperate to advance their mutual interests. The partners in a partnership may be individuals, businesses, interest-based organizations, schools, governm ...
, certain qualified
precious metals Precious metals are rare, naturally occurring metallic chemical elements of high economic value. Chemically, the precious metals tend to be less reactive than most elements (see noble metal). They are usually ductile and have a high lu ...
,
private equity In the field of finance, the term private equity (PE) refers to investment funds, usually limited partnerships (LP), which buy and restructure financially weak companies that produce goods and provide services. A private-equity fund is both a t ...
, and
tax liens A tax lien is a lien which is imposed upon a property by law in order to secure the payment of taxes. A tax lien may be imposed for the purpose of collecting delinquent taxes which are owed on real property or personal property, or it may be ...
. While the type of investment allowed in an IRA is broadly defined, the SEC has issued an investor alert explaining why using this type of IRA might present increased risk of fraud. 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. However, using a self-directed IRA to invest in an active trade or business via a pass-through entity such as an LLC or partnership can trigger a tax as the income generated would be treated as unrelated business income, subject to the unrelated business income tax (UBIT). A self-directed IRA can hold precious metals, which are typically held by a third-party custodian. The regulations pertaining to investing in precious metals are in Section 408(m)(3) of the Internal Revenue Code. There are exceptions for certain gold, silver, or platinum coins, as well as certain coins issued by a State treasury. Some popular State treasuries that are permissible coins include American Eagle coins,
Canadian Maple Leaf coins The Canadian Maple Leaf coins are bullion coins of gold, silver, platinum, or palladium, issued by the Royal Canadian Mint: * Canadian Gold Maple Leaf * Canadian Silver Maple Leaf The Canadian Silver Maple Leaf is a silver bullion coin that is is ...
, and Australian Koala bullion coins. In order for coins to be held inside an IRA, coins must satisfy a certain level of pureness in their mineral content so that they are not viewed as a type of collector's coin. As a result,
Double Eagle A double eagle is a gold coin of the United States with a denomination of $20. (Its gold content of 0.9675 troy oz (30.0926 grams) was worth $20 at the 1849 official price of $20.67/oz.) The coins are 34 mm x 2 mm and are made from ...
gold coins (minted in the United States in the nineteenth and early twentieth centuries) and South African
Krugerrands The Krugerrand (; ) is a South African coin, first minted on 3 July 1967 to help market South African gold and produced by Rand Refinery and the South African Mint. The name is a compound of ''Paul Kruger'', the former President of the South Af ...
are disallowed because they do not meet this standard. Bullion is also permissible if it meets a standard level of fineness and is produced by a COMEX or NYMEX approved refiner. An IRA can purchase any type of real estate as long as the provider (aka custodian) of that IRA handles real estate. IRA providers that handle real estate are often called self-directed IRA providers. If the IRA does not have enough cash to pay the full purchase price, then the IRA can partner with a person, company/entity, or another IRA, or it can secure a
non-recourse loan Nonrecourse debt or a nonrecourse loan (sometimes hyphenated as non-recourse) is a secured loan (debt) that is secured by a pledge of collateral, typically real property, but for which the borrower is not personally liable. If the borrower def ...
to buy real estate. Whether the IRA is whole or part owner, IRA funds are used for purchase, maintenance, and expenses. The funds that can be used include taxes, bills, and homeowner association (HOA) fees. When the property generates cash either with rental income or from a sale, those funds go directly back to the IRA. The IRS prohibits certain actions. For example, neither the IRA holder nor any disqualified persons (including family members) to that plan may live in or vacation in the property. The IRA holder makes the decisions about how the asset is maintained but cannot do the work themselves. IRA funds are allowed to be invested in private companies. The IRS puts restrictions on private investments that can be made by an IRA. It cannot purchase stock that the IRA holder already owns. Earnings from the entity may be subject to UBIT if the company has earnings from debt or has earnings from the sale of products or services. In most cases, neither the IRA holder nor any disqualified persons to the plan can be employed by the company while the IRA has an equity position in that company. The IRA cannot be a general partner in an LP or LLP, and it cannot invest in an
S-corporation An S corporation, for United States federal income tax, is a closely held corporation (or, in some cases, a limited liability company (LLC) or a partnership) that makes a valid election to be taxed under Subchapter S of Chapter 1 of the Internal ...
. Unlike prohibited transactions that are rules governing IRAs, the restriction on IRA investment in an S-corporation is an IRS S-corporation rule. An entity is not eligible for Subchapter S taxation if it has IRA shareholders, and its S-corporation election would be terminated if an IRA becomes a shareholder. The IRS allows IRAs and other retirement accounts to make loans. The IRA holder assumes the responsibility of choosing the borrower, principal amount, interest rate, length of the term, payment frequency, and amount of the loan. The holder also negotiates whether or not the note will be secured. Other self-directed IRA investments are often chosen by the IRA holder's expertise in a certain area of investing. The self-directed IRA is very popular with retirement investors looking to invest in real estate and cryptocurrency investments.


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 persons, as defined under Internal Revenue Code Section 4975. Such transactions would allow a disqualified person to bypass the rules relating to distributions and receive immediate benefit from the account, defeating its purpose as a long-term savings account. Understanding the rules on prohibited transactions is particularly important for the owner of a self-directed IRA, who has a wider choice of investment assets than the owner of an institutional IRA. In general, the IRA should not deal in any asset or business that benefits the owner, a relative of the owner, or anyone providing administrative services for the account (except in accordance with
fiduciary A fiduciary is a person who holds a legal or ethical relationship of trust with one or more other parties (person or group of persons). Typically, a fiduciary prudently takes care of money or other assets for another person. One party, for exa ...
duty). The self-dealing and conflict-of-interest types of prohibited transactions, as outlined in IRC sections 4975(c)(1)(D) and 4975(c)(1)(E), are the broadest and most complex categories of prohibited transaction. To trigger a self-dealing or conflict of interest transaction, the IRS simply has to show that a disqualified person received some direct or indirect personal benefit. 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 value The fair market value of property is the price at which it would change hands between a willing and informed buyer and seller. The term is used throughout the Internal Revenue Code, as well as in bankruptcy laws, in many state laws, and by sever ...
s 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.


Prohibited asset types

Internal Revenue Code Section 408 prohibits IRA investments in
life insurance Life insurance (or life assurance, especially in the Commonwealth of Nations) is a contract between an insurance policy holder and an insurer or assurer, where the insurer promises to pay a designated beneficiary a sum of money upon the dea ...
and in collectibles, such as
artwork A work of art, artwork, art piece, piece of art or art object is an artistic creation of aesthetic value. Except for "work of art", which may be used of any work regarded as art in its widest sense, including works from literature ...
, rugs,
antiques An antique ( la, antiquus; 'old', 'ancient') is an item perceived as having value because of its aesthetic or historical significance, and often defined as at least 100 years old (or some other limit), although the term is often used loosely ...
,
metals A metal (from Greek μέταλλον ''métallon'', "mine, quarry, metal") is a material that, when freshly prepared, polished, or fractured, shows a lustrous appearance, and conducts electricity and heat relatively well. Metals are typical ...
(there are exceptions for certain kinds of
bullion Bullion is non-ferrous metal that has been refined to a high standard of elemental purity. The term is ordinarily applied to bulk metal used in the production of coins and especially to precious metals such as gold and silver. It comes fro ...
),
gems Gems, or gemstones, are polished, cut stones or minerals. Gems or GEMS may also refer to: Arts, entertainment and media * ''Gems'' (Aerosmith album), 1988 * ''Gems'' (Patti LaBelle album), 1994 * ''Gems'' (Michael Bolton album), 2011 *Gems TV, a ...
,
stamp Stamp or Stamps or Stamping may refer to: Official documents and related impressions * Postage stamp, used to indicate prepayment of fees for public mail * Ration stamp, indicating the right to rationed goods * Revenue stamp, used on documents ...
s,
coins A coin is a small, flat (usually depending on the country or value), round piece of metal or plastic used primarily as a medium of exchange or legal tender. They are standardized in weight, and produced in large quantities at a mint in order t ...
,
alcoholic beverages An alcoholic beverage (also called an alcoholic drink, adult beverage, or a drink) is a drink that contains ethanol, a type of alcohol that acts as a drug and is produced by fermentation of grains, fruits, or other sources of sugar. The cons ...
, and certain other tangible personal property. Life insurance is prohibited as it is designed to benefit an individual's heirs, who are disqualified from directly benefiting from a self-directed IRA. Collectibles are prohibited as they are difficult to value.


Checkbook control

Checkbook control, also called a "checkbook IRA," is one strategy for a self-directed IRA where the account holder personally executes the investments. In this approach, the taxpayer establishes and manages a
limited liability company A limited liability company (LLC for short) is the US-specific form of a private limited company. It is a business structure that can combine the pass-through taxation of a partnership or sole proprietorship with the limited liability ...
(LLC) that has the IRA as its only investor. The taxpayer contributes to the IRA with instructions to invest the contribution into the LLC. After this is done, the taxpayer can personally conduct investment transactions on behalf of the LLC. The IRA custodian has no involvement in these internal transactions, but deals only with contributions and distributions. Although the IRS challenged checkbook control as an unlawful self-dealing arrangement, its argument was rejected by the
United States Tax Court The United States Tax Court (in case citations, T.C.) is a federal trial court of record established by Congress under Article I of the U.S. Constitution, section 8 of which provides (in part) that the Congress has the power to "constitute Tr ...
in ''Swanson v. Commissioner'' (1996).Maeda, Martha (2009) ''The Complete Guide to IRAs and IRA Investing''


See also

*
403(b) In the United States, a 403(b) plan is a U.S. tax-advantaged retirement savings plan available for public education organizations, some non-profit employers (only Internal Revenue Code 501(c)(3) organizations), cooperative hospital service organiz ...
*
Comparison of 401(k) and IRA accounts This is a comparison between 401(k), Roth 401(k), and Traditional Individual Retirement Account and Roth Individual Retirement Account accounts, four different types of retirement savings vehicles that are common in the United States. Comparis ...
*
Roth 401(k) The Roth 401(k) is a type of retirement savings plan. It was authorized by the United States Congress under the Internal Revenue Code, section 402A, and represents a unique combination of features of the Roth IRA and a traditional 401(k) plan. Si ...
* Rollovers as Business Start-Ups *
Self-invested personal pension A self-invested personal pension (SIPP) is the name given to the type of UK government-approved personal pension scheme which allows individuals to make their own investment decisions from the full range of investments approved by HM Revenue and ...
in the United Kingdom


References

{{reflist


External links


IRS Publication (2020), Individual Retirement Arrangements (IRAs)