How to Handle a Self-Directed IRATraditional and Roth IRAs are great tools to use for financial, estate, and retirement planning. One way individuals “turbocharge” their IRA’s performance is to use a self-directed IRA. This is able to hold alternative investments that offer potentially higher returns. Although this is a useful feature, there could be some tax-traps that have the ability to throw a wrench into your plans. That is, if your self-directed are not carefully attended to.
Tax AdvantagesUsually, IRAs offer a limited amount of stocks, mutual funds or bonds. Certain financial institutions have the option of choosing a self-directed IRA that allows people a wide menu of investments. This includes interests in LLCs and partnerships, precious metals, real estate, and closely held stocks. With a higher flexibility for investments, self-directed IRAs allow for more diversification and a potentially substantially higher return on investments. These types of IRAs can also provide valuable estate planning opportunities. This can allow you to transfer assets such as closely held stock and real estate to your children or other family members at a tax-advantage. It is important to note that self-directed IRAs cannot invest in certain kinds of assets. Such as, S corporation stocks, collectibles (i.e., art or coin collections), and insurance contracts.
Tax-TrapsThere are several complex rules regarding a self-directed IRA, and one mistake could cost someone any hope of utilizing this IRA’s benefits. The most destroying trap is the “prohibited transaction rules”, which restricts transactions between “disqualified persons” and an IRA. Disqualified persons are the account holder, the IRA’s beneficiaries, specific members of the account holder’s family, business(es). The account holder or his/her family control, and specific service providers and advisors to the IRA. All disqualified persons are prohibited from taking part in a number of transactions, including:
- Selling or buying property from the IRA,
- Lending money or guaranteeing a loan to the IRA,
- Promising IRA assets as collateral for a loan,
- Furnishing services or goods to the IRA,
- Receiving compensation from the IRA, or
- Personally use the IRA’s assets.