Costs and Benefits of Establishing a Self-Directed IRA
I published an earlier article discussing an increasingly popular alternative investment structure: the “self-directed” IRA. The self-direct IRA seems to be growing in popularity for many reasons. First and foremost, many investors are seeking diversification. They may not be inclined to put all of their retirement funds into traditional investment structures. Plus, it is important to keep in mind that you don’t have to give up your other investments to establish a self-directed IRA. It is perfectly fine to only use a portion of your retirement assets to fund a self-directed IRA. This is a good idea and one that I endorse. No one should put all of their assets in a single type of retirement account.
Along with diversification, some investors prefer putting their assets into tangible assets like real estate, precious metals, loans, and so forth. Investor also appreciate the fact that, with interest rates at historic lows, there is a lot of potential for making great returns in real estate. This is especially true for self-directed IRAs where a property purchase is done using cash exclusively. This gives the self-directed IRA an advantage for seller who simply need cash right away and are willing to sell a property for a reduced price if they can get the cash immediately.
One of the most common real estate investments utilized by self-direct IRAs is the all-cash purchases of rental properties, particularly residential rental properties. This can be a fantastic strategy to establish a long-term stream of steady, passive income. This doesn’t mean you can’t finance a real estate purchase with a self-directed IRA, but the process is more complicated.
Other popular investments made by self-directed IRAs include privately-held business. This can be a good investment if you set up a IRA-owned LLC. But keep in mind, this type of investment also has many legal considerations that you must be aware of. For example, the type of private business you invest in can impact the tax consequences to your self-directed IRA. Furthermore, if you get personally involved with the business, you may be at risk of violating the tax code. For example, Section 4975(c)(1) disallows certain interactions between an IRA and people that are “related” to the IRA account holder. Under the code, the “related” people are called disqualified people. The term “disqualified person” includes certain business partners, directors, and employees in businesses that are owned by you or your relatives.
If you’re considering setting up a self-directed IRA, I strongly encourage you to sit down with an experienced estate planning attorney to discuss the process. An estate planning attorney can ensure the self-directed IRA is set up properly and you are advised of any potential pitfalls and legal difficulties that could arise.
About the Editors: InSight Law is an estate planning firm in Ashburn, Virginia (VA).The firm’s areas of practice include estate planning, business planning, trust and probate administration, assisting veterans and their family members with obtaining benefits, and medicaid planning. If you have questions, don’t hesitate to contact our office at 703-654-6019. We’re here to help.