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A Self-Directed Individual Retirement Account (SDIRA) is an IRA that requires the account owner to make investment decisions and investments on behalf of the retirement plan. IRS regulations require that either a qualified trustee, or custodian hold the IRA assets on behalf of the IRA owner. Generally the trustee/custodian will maintain the assets and all transaction and other records pertaining to them, file required IRS reports, issue client statements, assist in helping clients understand the rules and regulations pertaining to certain prohibited transactions, and perform other administrative duties on behalf of the Self-directed IRA owner for the life of the IRA account. Self-directed IRA accounts are typically not limited to a select group of asset types (e.g., stocks, bonds, and mutual funds), and most truly self-directed IRA custodians will permit their clients to engage in most investments, if not all, of the IRS permitted investment types (an almost unlimited array of possibilities including foreign real estate). Some of the additional investment options permitted under the regulations include, but are not limited to, real estate, stocks, mortgages, franchises, partnerships, private equity and tax liens.
Prohibited activities and penalties
Self-directed IRAs, by allowing a wide range of investment choices, improve the account owner's opportunities to diversify their IRA portfolio(s). Some investments, such as life insurance, collectibles, or prohibited transactions with disqualified persons as defined by the Internal Revenue Service in IRC 4975(c)(1) , are not permitted in IRAs. Also, if real estate or any other investment asset held in a self-directed IRA has been employed for personal use, or to gain any other personal benefit (other than a return for the IRA), in the view of the IRS or the Department of Labor, the IRA(s) may become immediately taxable. In addition, if the IRA owner is younger than 59 1/2, the IRA will be subject to an early withdrawal penalty of 10%. It is important, however, to understand that the IRA account holder is responsible for compliance with all codes and regulations. While a custodian's job is to follow the directions of the account holder as a non-discretionary trustee, a custodian cannot ensure compliance or give legal or tax advice. Therefore, those interested in self-directed IRAs should seek education offered by an unbiased source.
Limited liability company structured IRA and the Swanson decision
In an effort to reduce fees, paperwork, and processing delays, some self-directed IRA investors choose to employ a Limited Liability Company (LLC) IRA structure. In such a structure the account holder directs his IRA custodian to invest into a limited liability company that he manages himself. The account holder can then execute transactions on the LLC level without the involvement of the IRA custodian, thus reducing fees and eliminating custodian transactional fees and delays. The profits of the LLC pass through to the IRA with nearly identical tax favorable treatment. Some claim that this IRA LLC strategy has been legitimized through a tax court case: Swanson v. Commissioner, 106 T.C. 76 (1996). Others disagree on the validity of the court case. Some refer to this structure as "checkbook control" because the IRA account holder often has sole signing authority for the LLC and its bank accounts. Similar checkbook control for a self-directed 401(k) plan would not require an LLC because Internal Revenue Code Section 401 does not mandate the use of a custodian.
Contribution limits and types of self-directed IRAs
Contributions limits for 2010 are $5,000 (or $6,000 for those age 50 and above.) A traditional IRA comes in two flavors: deductible and nondeductible. To see if you qualify for a deductible IRA, which lets you deduct all or part of your contributions from your taxable income, use the following guidelines: If you have no retirement plan at work and you're under 70-1/2, you can invest in a deductible IRA and deduct the entire amount from your taxes. If you have a 401(k) or other retirement plan at work, you may fully or partially deduct your contribution only if your adjusted gross income (AGI) qualifies. In 2010, your AGI cannot exceed $65,000 if you're single or head of household, or $109,000 if you're married and filing jointly. If you're not covered by a retirement plan, but your spouse is, you may qualify for a full or partial deduction if you file jointly and your AGI is below $177,000. (The same rule applies if you're a non-working spouse of someone covered by a retirement plan at work.) If you're not eligible to contribute to a deductible IRA, you may be eligible to contribute to a Roth IRA if your AGI is below $120,000 if you're single or $177,000 if you're married filing jointly.
Starting in 2010, the $100,000 modified AGI limit for conversions to Roth IRAs has been eliminated. This means that married couples filing separate returns can now convert amounts to a Roth IRA.
The above contribution limits can be found in Publication 590 at www.irs.gov.
Choosing the type of self-directed IRA
If you make too much to qualify for a Roth IRA and are not eligible for a deductible IRA, a nondeductible IRA is a valid option. Your contribution won't be deductible, but at least your savings will grow tax-deferred. So which IRA is best for you? The nondeductible is the least attractive, so open one only if you don't qualify for the other two. The choice between a deductible and a Roth is more difficult, but generally you're better off in a Roth if you expect to be in a higher tax bracket when you retire.
References
- Marino, Vivian (April 17, 2005), "Using an IRA to Buy Real Estate", New York Times
{{citation}}: CS1 maint: date and year (link) - Take charge of your IRA. CNNMoney.com