You may have heard of Traditional IRA or Roth IRA, but what is “Self-Directed” IRA or how does it work? Before we dive in, I want to mention the standard disclaimer that I’m not a licensed financial advisor or a CPA nor do I play one on TV. If you have specific questions on retirement planning or risk/return of a certain asset class or investment vehicle please consult the appropriate professionals or ask me for referrals.

What is Self-Directed IRA?

Put it plainly, Self-Directed IRA (SDIRA) is not significantly different than any other IRA. It has the same contribution limit, early withdrawal penalties, and minimum distribution requirements as Traditional or Roth IRA. What makes it unique is the ability to invest in non-traditional assets, meaning something other than stocks, bonds, mutual funds, and CD’s. You can invest in precious metals, private market securities such as pre-IPO shares of a startup, or even a race horse! What we will focus on more later is how to invest in real estate through SDIRA tax-deferred.

SDIRA has actually been around the same time as Traditional or Roth IRA when they were established in 1974. The reason it hasn’t received as much attention is due to the promotion and advertising from banks and brokerages that offer traditional investments and the illiquid nature or higher inherent risk non-traditional assets have. Can you quickly look up what’s the price of a 3-year-old thoroughbred? Didn’t think so.

The process for creating and funding a SDIRA is the same as a regular investments account. You can roll over a 401(k) when you leave a company or your existing investment account. All you have to do is to provide the transfer authorization and delivery instructions to the custodians and they can get you started.

Prohibited Asset Types and Transactions Within self-directed IRA

SDIRA is great for tax-deferred growth but you need to be careful because one wrong decision could trigger a taxable event and penalty. The following are NOT allowed within a SDIRA:

  • Collectibles (artworks, stamps, antiques, rare coins, etc)
  • Life insurance
  • S-corp – this is more of a rule under S-corp instead of IRS tax code
  • Personal use
  • Disqualified individuals: You may not buy/sell to/from an individual that are
    1. Fiduciaries (which in this case includes you, the IRA owner).
    2. The following family members of the IRA owner:
      1. Spouse;
      2. Parents;
      3. Grandparents and Great-Grandparents;
      4. Children (and their spouses);
      5. Grandchildren and Great-Grandchildren (and their spouses).
    3. Service providers of the IRA (e.g., IRA custodian, CPA, financial planner).
    4. 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

The IRS does not really spell out what’s permitted within SDIRA, therefore as long as it’s not within the prohibited asset class class or transaction type listed above it is considered fair game.

Self-direct for real estate

Technically you can invest in any kind of real estate through SDIRA, but with the contribution limit it’s kind of hard to buy a rental property in the state of California where I live. Aside from that, here are some other typical ways to invest in real estate through SDIRA:

  • Tax lien
  • Private placement
  • Mortgage notes
  • Private lending

Do note that when you take title or ownership it has to be in the IRA’s name and you not do any of the work yourself. This means if it’s a fixer-upper you’re flipping you can’t swing a hammer yourself. If it’s a rental income you’re not allowed to help the tenant fix the leaky toilet and the rent collected needs to go to IRA not you. All expenses and income have to flow through the IRA as well. When you commingle IRA funds and personal funds it is a violation and can create awful taxable event and penalties.

Fees involved with Self-directed IRA

Fees vary largely due to the wide range of services SDIRA custodians offer. Typically you will see a mix of one-time establishment fee to open your account, annual or renewal fees, and transaction specific fees that come out to probably a couple hundreds of dollars each year.

The one great thing about SDIRA custodians is that they are simply performing the service and they don’t have a specific product to sell you or get commissions based off of those transactions compared to a normal brokerage.

I want to thank the panelist that came to speak at our Meetup. If you have specific questions related to self-directed IRA be sure to reach out to them:

Bill Neville, CISP – The Entruss Group
Eric Golub – IRA Services Trust Company

Be sure to subscribe to our Meetup group to find out all the interesting upcoming topics we’ll be discussing!