Self Directed IRA (SDIRA)

What are Self-Directed IRAs?
A Self-Directed IRA is technically not any different than other IRAs (or 401ks). The government created the IRA to allow investments to grow tax-free or tax-deferred compounded over time to maximize growth. The IRA can also qualify for yearly tax-deductions (depending on the account type), provide asset protection, and assets may be passed to future generations for qualifying accounts.

A self-directed IRA is unique due to the available investment options and because it puts the IRA owner in control.

Most IRA custodians only allow approved stocks, bonds, mutual funds and CDs. A truly self-directed IRA custodian allows this type of investing in addition to real estate, notes, private placements, tax lien certificates and much more.

Self-Directed IRAs are Critical to Your Financial Future

As with any IRA, the goal of the account is to provide for your financial future. Your financial future is important, the reality of today’s investing environment is this: Social Security, pensions, and other government programs are in trouble and could be unreliable to support your retirement. The stock market is volatile and just leaving money in a savings account could allow inflation to cripple your nest egg.

The Power of Self-Directed IRAs
If you have knowledge, expertise, and success with investments outside the market (or you are looking to truly diversify and take control of your financial future) Self-Directed IRAs could be the key to your financial dreams.

Self-Directed IRA Advantages to Creating Financial Freedom

  1. Investing Diversity: With a Self-Directed IRA you can diversify beyond the market into assets such as real property, tax liens, mortgage notes, precious metals, foreign currency, plus much more. If you have expertise with a certain asset type, you can invest in what you know best to create and secure your financial future.
  2. Tax-Advantages = Lasting Wealth: Investing over time in a tax-advantage account like a Self-Directed IRA (tax-deferred/tax-free profits, plus the possibility of large tax deductions) can have a tremendous affect on future wealth (see chart below). Combine those benefits with the ability to truly diversify and invest in a full range of assets could be a winning combination.
  3. Secure Hard-Earned Assets: Self-Directed IRAs are afforded protection under federal bankruptcy laws to ensure assets are secure.
  4. Provide Wealth for Your Future Generations: Certain Self-Directed IRAs allow the passing of assets to beneficiaries after death with little or no tax implications, allowing you to stretch wealth over generations.

Self-Directed IRA Rules
If you don't follow the rules for self-directed IRAs, you can risk the tax-deferred status of your account. This could lead to the disqualification of the IRA and result in severe tax consequences.

Here is what you need to know:

Prohibited Transactions
A prohibited transaction can bring into question the tax-deferred status of your account, potentially resulting in the disqualification of your IRA and severe tax consequences.

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, lineal descendant, and any spouse of lineal descendant)."--Source IRS Publication 590

Publication 590 indicates that, in addition to prohibited investments, the IRS prohibits certain transactions within IRAs. Prohibited transactions include investments with disqualified individuals (as defined by IRC 4975), “self-dealing” and receiving indirect benefits.

Permitted Investments
The IRS does not provide guidance on what is permitted, but dictate only what is NOT permitted. Examples of prohibited IRA investments include collectibles (such as artwork, stamps, rugs, antiques and gems), certain coins and life insurance. See IRS Publication 590 for more information about prohibited investments.

Disqualified Individuals
Your IRA may not buy an investment from or sell an investment to a disqualified person as defined by Internal Revenue Code Section 4975. To do so is known as “self dealing”.

Additionally, investments made with self-directed IRA funds must be at arms length, which is most often defined as a willing buyer and willing seller coming together with no undue influence from outside sources.

Disqualified Persons Defined
Disqualified persons are individuals or entities between whom or which an IRA is prohibited (absent a special exception) from engaging in any direct or indirect sale or exchange or leasing of any property; lending of money or other extension of credit; furnishing goods, services or facilities; or transferring to or permitting the use of IRA income or assets.

  • Fiduciaries (which in the case of a self-directed IRA includes you, as the IRA owner).
  • The following family members of the IRA owner:
    • Spouse;
    • Parents;
    • Grandparents and Great-Grandparents;
    • Children (and their spouses);
    • Grandchildren and Great-Grandchildren (and their spouses).
  • Service providers of the IRA (e.g., IRA 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; also a partner which holds 10% of a joint venture of such entity.

Note: The term “disqualified person” under the Internal Revenue Code does not include siblings (brothers and sisters) or aunts, uncles and cousins of the IRA owner.

Indirect Benefits Rules
The purpose of the IRA is to provide for your retirement in the future. It is considered an “indirect benefit” if your IRA is engaged in transactions that, in some way, can benefit you personally today.

Indirect Benefit Examples
The following are just a few types of indirect benefit transactions that are NOT allowed in an IRA:

  • Personally using property held in the IRA: Using real estate purchased through your IRA— as an office, personal residence, vacation home or retirement home.
  • Receiving personal benefits from your IRA: Lending yourself money from your IRA or paying yourself, or a company that you own, to do work on a home purchased by your IRA.
  • Using your IRA funds to buy a vacation home that you or your family will use.

UBIT (Unrelated Business Income Tax)
If your IRA owns an asset or interest that produces unrelated business taxable income (UBIT), your IRA may be subject to an unrelated business income tax (UBIT) pursuant to Section 511 of the Internal Revenue Code.

Is My IRA Responsible for UBIT?
UBIT applies if ALL of the following are true:

  • Income is derived from "trade or business" activity (i.e., sale of goods and services).
  • Business activity is not substantially related to exempt status.
  • Business is regularly carried on by organization.

Generally, IRA investments that can generate UBIT include limited partnerships, limited liability companies, and any investment that incurs debt financing and/or is involved in an unrelated business.

Most passive investment income—including dividends, royalties, and rent—is exempt from UBIT. However, an investment that generates income with debt financing (e.g., purchasing real estate with a non-recourse loan in an IRA) is responsible for UBIT in direct proportion to the gain/income that's debt financed.

Payment of UBIT
In most cases, IRAs that receive more than the current $1,000 UBIT exclusion must file Form 990T with the Internal Revenue Service on or before the April 15th deadline. Form 990T payments must be made from the IRA's assets, and Equity Trust must receive direction to pay these taxes at least 10 days before the due date (plus any extensions).

IRAs that generate less than $1,000 of UBIT are not required to file Form 990T.

In most instances, UBIT is reported on Schedule K-1, which is prepared by the investment sponsor.

Self-Directed IRA FAQs

What is a Self-Directed IRA?
Technically speaking, a Self-Directed IRA is not any different than any other IRA (or 401k), however what makes a self-directed IRA unique is the available investment options.

Most IRA custodians only allow approved stocks, bonds, mutual funds and CDs. A truly self-directed IRA custodian allows those types of investments in addition to real estate, notes, private placements, tax lien certificates and much more.

What are the benefits of a Self-Directed IRA?
In addition to the tremendous IRA benefits (tax-free profits, tax deductions, asset protection and estate planning), you are able to invest tax-free in investments that you know and understand, which through the power of compounding interest, will create lasting wealth for you and your family.

Why haven’t I heard of a self-directed IRA before?
Self-directed IRAs may seem like a recent phenomena, but they have been around since the IRA was created in 1974. Investing in alternatives to stocks, bonds, and mutual funds has always been allowed by the IRS (see IRS Publication 590). Self-Directed IRAs have not received large attention because most custodians who offer IRAs (banks and brokerage firms) only allow traditional investments at their firms.

My CPA/Attorney/Financial Advisor hasn’t heard of a self-directed IRA, what should I do?
A trusted advisor who has not heard of self-directed IRAs is not an entirely uncommon experience, given their relatively unknown nature.

We work with professional advisers across the country to educate them regarding IRA and self-directed IRA rules so they can best customize advice to meet your personal needs.

If your adviser is not familiar with self-directed IRAs, he/she can contact a Partners South Retirement Specialist at 800.654.3170 x101.

Can I be assured that self-directed IRAs are allowed under IRA rules?
As long as you follow relevant rules the answer is yes.

There are specific rules regarding IRAs, and in particular, self-directed IRAs that you should be familiar with to ensure compliance.

There are certain types of transactions that you cannot perform through an IRA. Most importantly, the IRS prohibits “self-dealing,” which are investments in which you or your family members of lineal descent have prior ownership. For more information, please see Self-Directed IRA Rules.

How does a Self-Directed IRA investment work?
Investing with a self-directed IRA isn’t much different than investing outside of an IRA. In fact, in three simple steps you can be on your way to making tax-free or tax-deferred profits.

3 Simple Steps to Self-Directed IRA Investing

  1. Identify Your Investment and Request Funds
    Important: All documents related to the investment must be titled in the name of your IRA, not to you personally.
  2. Process the Investment
    We will review and process your forms. If everything is correct and approved, the funds will be sent from your IRA for the investment based on your specifications. All records pertaining to the investment (such as real estate deeds, original notes, operating agreements for LLCs) are retained for safekeeping.
  3. Manage and Sell the Investment
    Once your IRA owns the investment all expenses and profits related to the investment must come from and back to the IRA. When you are ready, you can then instruct to sell the investment on behalf of your IRA. Funds from the sale of the investment return to your self-directed IRA tax-free.

Are my Self-Directed IRA investments guaranteed?
No, investments held within your self-directed IRA are not guaranteed. Cash balances however, are held in FDIC insured accounts. For this reason self-directed investing may not be for everyone. Most successful investors feel that the investment risk in assets they know and understand is much less than that associated with investing solely in conventional IRAs.

Are self-directed IRAs for everyone?
Self-directed IRAs are not for everyone. They are for people who want true diversity in their portfolio, who want to be in control of their financial future and they are for those who want to create wealth using their knowledge of investments outside of stocks, bonds, and CDs.


Chamberlain Hrdlicka

IRA Services Trust Co.