Self-directed IRAs may provide more freedom than traditional retirement accounts, but with that freedom comes responsibility. Any violation of any of the many rules that govern self-directed IRAs could put you in violation with the IRS and incur significant tax and penalty costs.
Example: It isn’t permitted to invest in real estate you occupy or to buy and sell with certain individuals who are known as disqualified persons. Furthermore, it’s crucial that any investments made are legal.
1. Don’t Break the Rules
Self-directed IRAs allow for greater investment diversity when investing in alternative assets; however, their complexity makes it essential that investors have an in-depth knowledge of IRS rules and consult a tax or financial advisor prior to making investments – or else you could end up incurring penalties or losing tax-deferred status of their account.
Real estate transactions that violate IRS restrictions must also be avoided, for instance buying or renting properties owned by your IRA to yourself, direct relatives, or any disqualified parties; providing labor or services (for instance fixing up an investment rental home that needs repair) cannot also fall within this umbrella.
As there is a long list of prohibited activities, it’s crucial to stay aware of what’s allowed and not. According to the IRS, prohibited transactions include transactions that have the potential of producing unrelated business income (UBTI). These may include self-dealing, sweat equity agreements or lending money directly into an IRA account.
2. Don’t Forget About Fees
Self-directed IRAs involve numerous fees associated with alternative assets that must be considered, including transaction and custodian account management costs as well as asset-specific charges that could make investments less profitable over time.
Keep an eye out for prohibited transactions, which could derail any tax benefits you might hope to enjoy. Take care not to violate these rules or you could find yourself owing Uncle Sam come tax season.
There are ways around these fees if you’re willing to put in the work. One such way is establishing what’s known as a checkbook control IRA or LLC-controlled checking account. This will allow you to invest directly in nontraditional assets without needing a custodian and paying their fees; though this option requires more experience and may take longer.
3. Keep It Simple
Many are surprised to learn they can invest in anything from real estate and private companies to physical gold using their self-directed IRA, while also being unaware they must report its fair market value annually to the IRS – similar to how a traditional brokerage account would send its stock market statement.
Self-directed IRA custodians do not guarantee that any particular investment is safe or legitimate, leaving investors to assess opportunities, make smart investing decisions and avoid prohibited transactions on their own. That is why it is wise to consult an independent, impartial investment professional before making alternative asset investments with your SDIRA. Red flags to look out for include brand new investment promoters with no track record, unrealistically high returns claims without third-party oversight such as auditing by an established CPA firm – all potential indicators of fraud! Thankfully there are resources available to validate nonbank custodians offering SDIRA services claiming such as verification services available by nonbank custodians that claim to provide these services – all possible indicators of potential fraud! Luckily resources exist to verify any nonbank custodian claiming to offer self-directed IRA services claims from such claims by nonbank custodians which claim such claims.
4. Don’t Forget About Taxes
SDIRAs allow you to invest in nontraditional assets that might otherwise not be accessible, like real estate and startup equity, without incurring taxes upon withdrawal at retirement.
With increased flexibility comes greater responsibility, so it is your duty to scout investment opportunities carefully, avoid prohibited transactions, and comply with IRS rules and regulations.
Real estate investing requires following certain rules carefully, such as prohibitive transactions and disqualified renter exclusions; renting out your property for personal gain is also strictly forbidden, while adhering to self-dealing restrictions (i.e. providing services on an IRA-owned property or sleeping there yourself) should also be carefully observed.
Avoid this risk by teaming up with a nondisqualified individual to manage your investment or setting up what’s known as a checkbook control IRA, which entails setting up a limited liability company to own your property, opening a checking account with its name as its tax ID, then funding this account via your SDIRA.
