Guide to Setting Up a Self-Directed IRA

Self-directed IRAs create a tax haven for investing retirement funds in alternatives outside the stock market. It allows you to shelter gains while opening the door to investment opportunities not available in conventional IRA accounts. If you are interested in expanding your retirement portfolio, you need a self-directed IRA.

Alternative Investments You Can Hold in a Self-Directed IRA
The IRS code does not limit investment choices. Without a specific list of approved items, you can choose from a wide range of alternatives that may include the following:

  • Residential real estate
  • Commercial real estate
  • Private placements
  • Private real estate syndications
  • A membership interest in an LLC
  • Raw land
  • Promissory notes
  • Tax lien certificates
  • Cryptocurrency
  • Precious metals like gold and silver
  • Mineral rights
  • Livestock
  • Franchises

The IRS code does have a short list of prohibited items designed to prevent self-dealing. This list includes:

  • Collectibles such as gems, coins, artwork, antiques, some precious metals, and alcoholic beverages.
  • S Corporations
  • Life Insurance products

How To Set Up A Self Directed IRA
While self-directed IRAs give you more control over what and how you invest, you are not permitted to manage the investments yourself. The legislation requires a third-party custodian or trustee to hold the assets and send required reports to the IRS.

Identify the custodian: Companies must receive IRS approval before acting as the trustee or custodian for self-directed IRAs. Not all custodians are the same. Before choosing a company, compare the fees and services offered and their specialty and experience in your investment of choice.

The IRS maintains a list of approved nonbank trustees and custodians.

Roth or Traditional? Self-directed IRAs can accept funds from both traditional and Roth accounts. In most cases, you will keep the same account type. Converting a traditional IRA to a conventional self-directed IRA simplifies the process. However, there may be circumstances when you want to consider converting traditional IRA funds into a Roth IRA.

Accounts follow the same IRS rules as conventional IRA accounts with regard to tax benefits, taxation at withdrawal, age and income restrictions, and mandatory distributions.

Choose Your Investment: Self-directed IRAs offer more variety and flexibility than standard IRAs. However, you must complete your own due diligence before choosing an investment because the custodian only handles the transaction and completes required IRS reporting. They do not vet the investment or provide investment advice.

We cover the primary factors you must consider with self-directed IRAs here. (Link to what you need to know about SDIRAS)

Fund the Account: Once you choose the investment, you are ready to add money to the account. Funding involves the same process as any other IRA. You can make direct contributions, move money from an existing IRA, or transfer funds from a work-sponsored account. In some cases, you can move 401k funds even if you are still with your employer.

We detailed how to roll over funds from a 401k or work-sponsored account here. (Link to how to transfer a 401k to an IRA)

Purchase the investment: The trustee or custodian completes the transaction. To qualify, it must meet the regulations of the IRS code, which include avoiding:

  • Investments with a disqualified person (yourself, family members, IRA beneficiaries, to name a few)
  • Receiving a personal benefit (you cannot personally benefit from the investment. For example, buying a vacation home that you or a disqualified person personally uses.
  • And not participating in a disallowed investment (examples include collectibles, life insurance, and S corporations).

After the purchase, you must follow IRS rules and file the appropriate annual schedules to retain the preferred tax treatment.

Learn more about investing in real estate syndications with a self-directed IRA in our introductory video.

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