Self Directed IRA

What is an a "SELF DIRECTED IRA"?

  • An SDIRA is an IRA (Traditional or Roth) established with a custodian* (special broker) that facilitates investments into any qualified* investments
  • Created by rolling over existing IRA/401k OR can also establish a new IRA with a SDIRA custodian and has same contribution limits as typical IRA
  • YOU choose the investments, the broker facilitates the investment and paperwork!

Why establish an SDIRA? Why invest through an SDIRA?

  • Gives you the ability to invest money outside of the stock market
  • Provides you access to a diverse set of investments
  • Grants you more flexibility with your investments to maximize retirement account returns

What can an SDIRA invest in?

  • Real estate
  • Promissory notes 
  • Precious metals
  • Private company stock

How do you create a SDIRA?

  •  Set up an account with a SDIRA custodian (takes less than 15 minutes)
  • Fund the account with new funds or rollover from IRA / previous employer 401k
  • Custodian will initiate transfer from existing IRA / 401k
  • Send broker the investment opportunity and documents
  • Custodian reviews documentation to check for prohibited transaction
  • Custodian releases funds
  • As investment earns money, funds are sent to your retirement accoun

SDIRA Investment Limitations

  • SDIRA accounts are allowed to invest with any person or company that is not a "disqualified person"
  • SDIRA accounts are not allowed to invest with a "disqualified person"
    • Example: Your IRA is not permitted to invest in a company that is fully owned by you and or your spouse
    • Disqualified person is implied if the person owns 50% or more of the company
  • Investing with a "disqualified person" is a "prohibited transaction"

 

 

3 Types of prohibited transactions: per se, personal extension of credit, self-dealing

  1. Per Se - when an IRA engages in a transaction with a disqualified person
  2. Personal guarantee or extension of credit - IRA owner cannot guarantee a loan or obtain a loan personally on behalf of SDIRA.
  • Must use non-recourse debt or have someone that’s not disqualified take on recourse.  IRA cannot lend or take credit to/from disqualified person.
  • IRA can participate as a cash investor and have other partners that are not disqualified guarantee the loan

3. Self-Dealing - when the IRA owner or other disqualified person benefits from IRA’s investments

 

Consequences of prohibited transaction (can vary, but typical)

  • Creates a tax event
  • Entire IRA becomes disqualified - entire account is distributed based on fair market value
  • Amounts distributed are subject to ordinary income tax and early withdrawal penalty of 10% on gross distribution
  • Not a legality issue, just loss of tax advantaged status for the IRA
  • One strategy implemented is to create multiple IRA so that if one IRA somehow is deemed to have engaged in a prohibited transaction, only that single IRA is impacted

SDIRA investing, UBIT and UDFI

UBIT- Unrelated Business Income Tax is a form of tax that is required to be paid on certain IRA investments. The tax is based on ordinary income received by an IRA and is taxed at 39.5% for income earned over $11,950 per year. UBIT CAN BE avoided through choosing correct SDIRA investment vehicles!

Common investments that cause UBIT:

UDFI- Unrelated Debt Financed Income is income that is received by an IRA account that is attributable to an investment that has debt. Common example of this is your IRA owning a rental house that has a bank mortgage. Income that is generated under UDFI is subject to UBIT.

UDFI Overview

  • UDF Income is paid at the UBIT tax rate
  • Applies to both operating income each year and capital gains at sale of business or property
  • Includes all debt financing on business or property
  • Requires a separate tax ID from IRS for the IRA to report and pay 990-T taxes

How is UDFI calculated?

  • Determine ratio of debt (average for the year) vs basis of the property (cost minus any depreciation); debt/basis 
  • Ratio is multiplied by income from property - this is subject to UDFI
  • Simple Example 
  • Average Debt $50,000
  • Property Basis $100,000
  • Ratio = 50%
  • Income = $20,000
  • Subject to UDFI = $10,000