Self-Directed IRAs: Frequently Asked Questions (FAQ)

Self-Directed IRAs offer investment freedom, but they require some explanation. Here are the answers to the most common questions we receive regarding Self-Directed IRAs.

1. What Is a Self-Directed IRA?

A self-directed IRA account allows the IRA to invest funds anywhere allowed by law.
The main reason most people don’t use Self-Directed IRAs is that the large financial institutions that administer most U.S. retirement accounts don’t think it's a good idea to hold real estate or non-publicly traded assets in retirement plans.

2. Can I "Roll Over" or Transfer My Existing Retirement Account to a Self-Directed IRA?

This depends on your situation:

Your Situation: Transfer/Rollover
I have a 401k or other
company plan with a current
No, in most instances your current
employer’s plan will make it impossible
until you reach retirement age.
I inherited an IRA and keep the
account with a brokerage or
bank as an inherited IRA.
Yes, you can transfer to a self-directed
inherited IRA.
I have a Traditional IRA with a
bank or brokerage.
Yes, you can transfer to a self-directed
I have a Roth IRA with a bank
or brokerage.
Yes, you can transfer to a self-directed Roth IRA.

I have a 403(b) account with a
former employer.
Yes, you can rollover to a self-directed
I have a 401k account with a
former employer.
Yes, you can rollover to a self-directed
IRA. If it is a Traditional 401k, it will be a
self-directed IRA. If it is a Roth 401k, it will be a self-directed Roth IRA

3. What Can I Invest in With a Self-Directed IRA?

The most popular self-directed retirement account investments include:
Rental real estate.
Secured loans to others for real estate (trust deed lending).
Private small business stock or LLC interests
Precious metals, such as gold or silver.

You May Not Invest In:

Collectibles such as artwork, stamps, coins, alcoholic beverages, or antiques
Life insurance
S-corporation stock
Any investment owned by someone in your close family.

4. What Restrictions Are There on Using a Self-Directed IRA?

When self-directing your retirement account, you must be aware of the prohibited transaction rules found in IRC 4975. These rules don’t restrict what you can invest in, but whom your IRA may transact with.
The prohibited transaction rules restrict your retirement account from transactions with someone who is disqualified. Disqualified persons include: the account owner, their spouse, children, parents, and certain business partners.

On the other hand, your retirement account could buy a rental property from your distant cousin, college roommate, friend, or a random third party.

5. Can My Self-Directed IRA Invest in My Personal Company, Business, or Deal?

No, it would violate the prohibited transaction rules if your IRA transacted with you personally or with a company you own.

6. What Is Checkbook Control?

Many self-directed retirement account owners, particularly those buying real estate, use an IRA LLC, also known as a “checkbook-control IRA”, to hold their retirement assets so that they have fast access.

7. Can I Get a Loan to Buy Real Estate With My IRA?

Your IRA can buy real estate using its own cash and a loan or mortgage. To do this, you must obtain a non-recourse loan.

A non-recourse loan is made by the lender against the asset. In the event of default, the sole recourse of the lender is to foreclose and take back the asset. The lender cannot pursue the IRA or the IRA owner for any deficiency.

8. Are There Any Tax Traps I Should Know About?

The Unrelated Business Income Tax, or UBIT, applies when your IRA receives unrelated business income. If your IRA receives investment income, that income is exempt from UBIT tax. Investment income exempt from UBIT includes the following:
Real Estate Rental Income: Rent from real estate is investment income and is exempt from UBIT.
Interest Income: Interest and points made from money lending is investment income and is exempt from UBIT.
Capital Gain Income: The sale, exchange, or disposition of assets is investment income and is exempt from UBIT.
Dividend Income: Dividend income from a C-Corp, where the company pays corporate tax, is investment income and exempt from UBIT.
Royalty Income: Royalty income derived from intangible property rights, such as intellectual property, oil, gas, or mineral leasing activities is investment income and is exempt from UBIT.
So, make sure your IRA receives investment income as opposed to “business income”.

9. What Is Unrelated Debt-Financed Income (UDFI)?

If an IRA buys an investment with debt, then the income attributable to the debt is subject to UBIT. This income is referred to as “unrelated debt-financed income” (UDFI), and it triggers an UBIT tax. This often occurs when an IRA buys real estate with a non-recourse loan.

For example, let’s say an IRA buys a rental property for $100,000, and that $40,000 came from the IRA and $60,000 came from a non-recourse loan. The property is now 60% leveraged, and as a result, 60% of the income is not a result of the IRA's investment, but the result of the debt invested. This debt is not retirement plan money, so your friends at the IRS will require you to pay tax on 60% of the income. So, if there were $10,000 in net rental income on the property then $6000 would be subject to UBIT taxes.

10. Should I Use an Individual 401k Instead of A Self-Directed IRA?

This is where things get interesting.

An individual 401k is a great self-directed account option, and can be used instead of an IRA for persons who are self-employed. If you are not self-employed, then the individual 401k may not work for you.
If you are self-employed and you want to maximize your contributions the individual 401k has much higher maximum contribution amounts: $54,000 annually versus $5,500 annually for an IRA. That’s a significant difference.

A self-directed IRA is a better option for someone who has already saved for retirement. Some funds can be rolled over and invested in a self-directed IRA.

If you are going to carry debt and you are self-employed, you are much better off choosing an individual 401k over an IRA. Individual 401ks are exempt from UDFI tax on leveraged real estate.

There are a lot of things to consider when rolling funds into an IRA. If you have additional questions, feel free to reach out to us.