Smart Ideas: Resources Revisited
U.S. tax codes require an IRA to be a trust or a custodial account built in the United States for the sole benefit of a person or the person’s beneficiaries. The account should abide by written instructions and satisfy specific requirements connected to holdings, distributions, contributions, and the identity of the custodian or trustee. These give rise to a special type of IRA known as a self-directed IRA (SDIRA).
The Differences between Self-Managed and Self-Directed IRA
All IRAs permit account owners to select from investment opportunities acceptable under the IRA trust agreement, and to buy and sell those investments upon the account owner’s good judgment, on the condition that the sale proceeds will remain in the account. The limitation on investor choice comes from IRA custodians being allowed to choose the types of assets they will handle within the limitations imposed by tax regulations. Most IRA custodians only permit investments in greatly liquid, easily valued products, like bonds, ETFs and CDs, mutual funds, etc.
However, a number of custodians are willing to manage accounts with alternate investments and to provide the account owner considerable control to “self-direct” such investments within the confines of tax regulations. The list of alternative investments is long, limited only by some IRS prohibitions against illiquid or illegal activities according to self-directed IRA rules, and the eagerness of a custodian to direct the holding.
The most frequently provided example of an SDIRA alternative investment is direct ownership of real estate, which may involve property redevelopment or a rental situation. Direct real-estate ownership is very different from publicly traded REIT investments, since the latter is typically available through more conventional IRA accounts.
Advantages of a Self-Directed IRA
The advantages provided by an SDIRA relates to the ability of an account owner to use alternative investments to accomplish alpha in a tax-privileged manner. In the end, SDIRA success depends on the unique knowledge or expertise of the account owner in terms of capturing returns that, after getting tweaked for risk, surpass market returns.
A general idea in self-directed IRA rules and regulations is that self-dealing, in which the IRA owner or other selected individuals use the account for personal gain or in a way that evades the intent of the tax law, is illegal. Major elements of self-directed IRA rules and regulations and compliance include identifying disqualified people and the kinds of transactions they are not allowed to initiate with the account. The effects of disobeying transaction rules can be severe, such as the whole IRA being declared by the IRS as taxable at its market at the start of the year in which the prohibited transaction took place, which means the taxpayer may need to pay settle deferred taxes, besides a 10% early withdrawal penalty.
Other than the IRA owner, self-directed IRA rules define a “disqualified person” as any person controlling the assets, disbursements, receipts and investments, or those who have an influence on investment decisions.