Choosing the Right Self-Directed IRA Custodian

There are many firms available today to help you establish and manage an individual retirement account (IRA). However, if you are interested in opening a self-directed IRA (SDIRA), you will need to find one of the few firms that have qualified custodians on their staff. Because a SDIRA offers both more freedoms, but also larger risks, hiring a reputable custodian is highly advised. These custodians are employed by specialized firms, like Royal Legal Solutions, and thoroughly understand the regulations established by the Internal Revenue Service (IRS). They can ensure your SDIRA is executed per your personal directions.

Do you think you can handle it yourself? Let us start with taking a look at the IRS regulations you may or may not be aware of.

SDIRA Tax Regulations

Under the Internal Revenue Code (IRC), the IRS establishes regulations that govern taxable incomes, exemptions, and much more. While these codes can be restrictive, they do not dictate what you can invest in with finances from your SDIRA. However, they do spell out what you legally cannot invest in. Under Section 408 and Section 4975, the IRC establishes the definition of a “disqualified person” and a “prohibited transaction.”

  • Disqualified Person: A “disqualified person” is a member of the SDIRA owner’s family, including their spouse, parents, children, grandchildren, and spouse’s ascendants. Other disqualified persons include any individual providing a service to the plan, employers and employees covered by the plan, and anyone who has 50% or more ownership of the plan.
  • Prohibited Transaction: A “prohibited transaction” is any transaction that occurs between a SDIRA and a disqualified person.

Prohibited transactions come in all shapes and sizes. For example, you are not allowed to lend money or provide any form of credit from your SDIRA to a disqualified person and vice versus. This means, you cannot borrow money from your SDIRA to purchase a home for yourself. You also cannot provide goods, services or facilities to a property owned by your SDIRA. If the pipes burst, your SDIRA account must hire a professional with its funds. Additionally, a disqualified person cannot use or benefit from the asset itself or any income it generates. Therefore, you cannot spend the night in the timeshare your SDIRA account owns. Prohibited transactions also include earning a salary for managing the properties owned by your SDIRA and loaning money from your SDIRA to a business you, or another disqualified person, owns.

Your Responsibilities

As noted above, a SDIRA is different from an IRA. While there are small differences, the two largest are the choices you have for investments and your level of control. A SDIRA is not limited to mutual bonds, stocks and bonds, as an IRA is. Instead, SDIRA owners can invest in real estate, precious metals, mortgage notes, private placements, renewable energy sources, and more. These options allow you to diversify your portfolio in a way a normal IRA will not. They can create much higher returns, however, they are also much riskier. As the SDIRA owner, you also have more controls, and therefore, more responsibilities. The SDIRA owner is responsible for all investment decisions. They must be diligent in their research, observations, monitoring and understanding of potential and actual investments. Because a SDIRA owner is liable for the decisions made regarding their account, they also must ensure they provide clear, understandable directions to their custodian.

Role of the Custodian

Your custodian performs actions on your behalf. If you do not yet have a SDIRA, they will assist you in opening an account and help you transfer funds into it. When you decide on your investments, your custodian will invest on your behalf. Per your request, they will make any distributions or pay for expenses, such as paying a plumber to fix the toilet in your SDIRA-owned rental property. As a reputable and knowledgeable professional, your custodian can also help to answer any questions you have about tax regulations and SDIRAs. They will also provide the IRS, or other government agencies, with any legally required reports on your behalf. This includes the IRS-required Form 1099R and Form 5498.
Terms and expectations of your custodian’s responsibilities should be made clear when you elect to hire them. Most firms require custodians to provide clients with quarterly financial statements regarding their SDIRA. Your custodian should also keep you informed of any business policies, fees, or regulations that will affect your account.

While there are several things your custodian will do, there is one major thing the IRS expressly prohibits them from doing. A SDIRA custodian cannot legally provide advice related to finances, such as investments or taxes.

Royal Legal Solutions

Royal Legal Solutions is one of those firms that can provide you with reputable, qualified custodians. Your SDIRA comes with plenty of opportunities to advance your retirement finances. It also comes with greater potential to unintentionally violate tax regulations. Hiring a custodian can help ensure your account does not do this. When you hire a custodian, make sure their fees and responsibilities are clearly established upfront.

Last Updated: 
April 23, 2018

Scott Royal Smith is an asset protection attorney and long-time real estate investor. He's on a mission to help fellow investors free their time, protect their assets, and create lasting wealth.

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