One of the best things about rolling over your retirement assets into a self-directed IRA is that it opens up a wide range of investment options—including our favorite, real estate.
Typically, IRA investment options are limited to stocks, mutual funds and bonds. Holders of a self-directed IRA, however, can also invest in:
With all those options, more and more individuals are converting their traditional IRAs to self-directed IRAs to take advantage of a very favorable market. There are, however, certain rules and restrictions that need to be followed in order to enjoy tax-free and tax-deferred status.
The IRS does not list what self-directed IRAs are allowed to invest in. On the other hand, it provides a detailed list of prohibited transactions and specifies what individuals are not allowed to invest in. Generally speaking, you cannot directly benefit from any investment you make with your IRA. For those that own property, the property must be held in the name of the IRA trust and not your own. Rent, for example, would be paid directly to the trust.
In addition, you can not hold property in your IRA that either you or your family members benefit from. This includes homes, businesses, and loans. You can’t borrow against your IRA to start your own business. Generally speaking, if you or your family reap immediate rewards from the holding of an asset in your IRA, that is disqualified.
While certain assets are restricted by the IRS, the IRS is most concerned with who is benefitting from the holding of the assets in an IRA. If it’s you or a member of your family, that will raise their eyebrows.
Self-directed IRAs significantly expand your options. They also afford you all the benefits that IRAs have to offer. What are some of those options and benefits?
Both traditional and self-directed IRAs enjoy tax-deferred status. Roth IRAs are essentially tax-free. Due to this preferred tax status, the IRS insists that certain rules are followed. Nonetheless, returns and contributions to non-Roth IRAs are tax-deferred. You won’t begin paying a dime in taxes until you begin taking distributions.
Roth IRAs, on the other hand, are taxed on their way into the account. You won’t pay taxes on either distributions or gains. Contributions to the Roth, however, are not deductible. There are also limitations on what you’re allowed to contribute depending on how much you make in a year. This is something to bear in mind when considering a Roth IRA.
Real estate is one under-utilized option for self-directed IRAs. So long as the real estate is property of the IRA trust, any money that the real estate generates is allowed to be entered in your IRA tax-deferred. This can include rent or gains from the sale. One restriction, however, is that neither you nor anyone in your family is allowed to reside in or take advantage of the property in any way. That would create a conflict of interest and potentially void your IRA.
IRAs are set up to receive passive income from such things as dividends. In fact, the IRS prefers that you pad your IRA with passive earnings. Traditional or non-self-directed IRAs relied on bonds and mutual funds to accrue value. You can still invest in stocks, bonds, and mutual funds, but with a self-directed IRA, you can choose which ones you invest in.
While the IRA expressly prohibits the use of your IRA to invest in collectibles, there are certain kinds of coins that gain their value intrinsically from what the coin is made of. Instead of being an investment in the coin, it’s considered a precious metal investment. The U.S. government mints such coins for this express purpose. So do most major countries across the globe. These coins are largely considered an acceptable form of investment for your IRA.
Another interesting option for your self-directed IRA is tax liens. Essentially, the government will sell liens on real estate where the owners have failed to pay property taxes. They will recoup their money in this manner. Meanwhile, interest is building on the unpaid taxes. If the owner fails to pay at all, the real estate will become property of the IRA. For the last decade or so, tax liens on real estate have become a very lucrative investment. With your self-directed IRA, you can reap the rewards tax-deferred.
This is a bit tricky, but it can be done. You’ll need to bear in mind that you cannot purchase an interest in any business belonging to “disqualified” persons. This basically includes anyone in your family or yourself. The IRA can own an interest in a business and have profits paid to the account, but the disqualified persons statute of the IRC must be abided absolutely. Otherwise, you risk the IRS considering the transaction a distribution thus voiding the IRA entirely.
You can purchase notes or make loans using your IRA. However, the same rules concerning disqualified persons still apply. Likewise, you can’t borrow against your IRA.
The IRS permits investors to use their IRA to invest in both foreign currencies and cryptocurrencies. Cryptocurrencies have made a lot of headlines recently, but the jury is still out on whether or not they constitute a good long-term SDIRA investment. It seems that if the technology to process transactions improves over the next few years, as everyone expects it will, then cryptocurrencies could represent a major disruptive technology that would change the face of global commerce forever.
Foreign currencies also represent an excellent investment option as they offer easier liquidity than stocks or bonds.
Self-directed IRAs have many advantages, not the least of which is that they allow tax-deferred earnings and unmatched investment options. Using your self-directed IRA to secure your future has never been easier or more effective.
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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