Are you someone who:
Is worried about the stock market?
Or didn’t know you could diversify your retirement funds with alternative assets?
Or doesn’t know the difference between a Custodial and Checkbook IRA?
Instead of cashing out your corporate 401K plan and paying penalties have you considered a Self-Directed IRA to start investing in real-estate or crypto currency?
This type of (IRA), provided by some financial institutions in the United States, which allows alternative investments for retirement savings. Some examples of these alternative investments are: real estate, private mortgages, private company stock, oil and gas limited partnerships, precious metals, horses, and intellectual property. The complexity of the rules for self-directed IRA’s prompted the SEC to issue a public notice in 2011 against an increased risk of fraud. In 2019, the maximum self-directed IRA and self-directed Roth IRA contribution is $6,000 or $7,000 if over the age of 50.
Internal Revenue Service (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 for all IRAs chooses among the investment options allowed by the IRA custodian. For regular IRAs these options usually include stocks, bonds, and mutual funds, 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 (IRC) restrictions.
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.
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, stocks, mortgages, franchises, partnerships, precious metals, private equity, cryptocurrencies and tax liens. 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. Some US government minted coins (American Eagles and American Buffalo) are permissible. Bullion is also permissible if it meets a standard level of fineness, and is produced by a COMEX or NYMEX approved refiner. 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 gold coins (minted in the United States in the nineteenth and early twentieth centuries) and South African Krugerrands are disallowed because they do not meet this standard.
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 to buy real estate. Whether the IRA is whole or part owner, IRA funds are used for purchase, maintenance, and expenses. When the property generates cash either with rental income or from sale, those funds go directly back to the IRA. The IRS prohibits certain actions. For example, neither the IRA holder nor any disqualified persons 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 IRA ownership of private equity is usually expressed as a percentage of ownership in the company or as a number of shares of stock. The IRS puts restrictions on private equity 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 a LP or LLP, and it cannot invest in an S-corporation.
Unlike prohibited transactions that are rules governing IRAs, the restriction on IRA investment in an S-corporation is an S-corp rule. A entity is not eligible for Subchapter S taxation if it has IRA shareholders and its S-corp election is 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, the principal amount and 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 LLC is very popular with retirement investors looking to invest in real estate and cryptocurrency investments because of the need to be more involved in the process and still keep custodian fees low.
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