Many of us have a large percentage of our investment assets in IRAs. We can choose between traditional IRAs and Roth IRAs. But most IRAs can be invested only in traditional assets, such as stocks, bonds, and mutual funds. The trend for investors now is to add non-traditional assets to their portfolios. With the right moves investors can put unconventional investments in IRAs.
No tax law or regulation prohibits an IRA from holding real estate, privately-issued company stock, mortgages, separately-managed accounts, or a number of other types of assets. It is the IRA custodians who limit IRAs to publicly-traded assets. They do this to reduce costs. Custodians have the responsibility to buy and sell the assets, ensure title to them, and place a value on them at least annually when they issue reports to the owners, among other things. These tasks can be done more easily and efficiently when only publicly-traded assets are in the IRA.
There are a few IRA custodians, however, that will hold unconventional and non-publicly-traded assets in the accounts. They charge additional fees for the accounts and for each of the services they offer. They also tend to have higher minimum investments than many conventional custodians. But an investor who has a large enough IRA will find the fees worthwhile if he identifies profitable investment opportunities.
Most conventional IRA custodians offer what they call self-directed IRAs. That means the owner can buy almost any publicly-traded asset. But a true self-directed IRA allows the owner to invest in a much broader range of assets. You can have a true self-directed IRA by taking a couple of steps. First, select an IRA sponsor. The box on page seven lists the more prominent national custodians for true self-directed IRAs. You can find others through your favorite Internet search engine. After selecting a custodian, transfer IRA assets to the new custodian.
From there, you can take either of two major routes. One route is to make all your investment transactions through the IRA. Direct the custodian to buy the assets you want to own and sell those you want to unload. The other route is to form a limited liability company and have the IRA buy the company. Then, all your investing is conducted through the LLC’s own checking and brokerage accounts.
The second approach can reduce the fees and paperwork imposed by the custodian, since it is making only the transaction to buy the LLC. Each year it will need to value the LLC, and that involves valuing the assets owned by the LLC. The LLC also will have to file annual tax returns in most cases. You should be able to elect to have it taxed as a partnership; there should be no taxes, because the IRA is the only owner.
Even with a true self-directed IRA, you cannot own all types of assets. The tax law prohibits all IRAs from owning life insurance and collectibles. Collectibles are works of art, antiques, rugs, stamps, coins, metals, gems, alcoholic beverages, and any other items identified by the IRS as collectibles.
Another group of limits are in the tax law’s prohibited transaction rules. These rules can be summarized as “do not make any transactions involving both the IRA and the owner or a related person.” The definition of a related person is very broad. Included are many of your relatives as well as any business entities owned fully or partially by you or your relatives. The penalty of engaging in a prohibited transaction is that the entire IRA is treated as distributed to the owner, and the value is included in the owner’s gross income.
There are both general and specific prohibited transactions. In the general category are: an act in which the related party deals with the IRA income or assets as his or her own; and the receipt of any benefit for the related party’s personal account in connection with a transaction involving the income or assets of the IRA.
The specific prohibitions are: a sale, exchange, or lease of property; a loan of money; furnishing goods, services, or facilities; a transfer to or the use of the income or assets of the IRA; and the transfer to or use of the income or assets of the IRA.
Your IRA can invest in a private company, if it is not owned by you or a related person. Your IRA can buy real estate, if it is not purchased from you or a related person. Your IRA can lend money in a mortgage, as long as you or a related person is not the borrower.
There are even more investments the IRA can make. It is possible to engage legally in prohibited transactions.
The Department of Labor allows IRAs to apply for exemptions from the prohibited transactions rules. Here are some exemptions granted in recent years:
The Department also grants “class exemptions” that are available to anyone meeting the qualifications stated in the class exemption.
You can get full details of past exemptions at the web site www.dol.gov/ebsa/. In the right column, click on “exemptions,” and then on the next page click “EXPRO Exemptions,” “Individual Exemptions,” and “Class Exemptions.” For full details about exemptions and procedures, get the booklet Exemption Procedures Under Federal Pension Law, available at www.dol.gov/ebsa/-publications/exemption_procedures.html.
This is a sample of the investment flexibility of a true self-directed IRA. That is why some people call it the Super IRA or Secret IRA. You should not use an LLC within the IRA or any transaction that is close to the prohibition transaction limits without first getting good tax advice.
Self-Directed IRA Sources
The following firms act as custodians for true self-directed IRAs. Fees, paperwork, and acceptable assets vary. Have a good idea of the investment strategy you want to use before comparing firms.
555 12th St., Suite 1250
Oakland, CA 94607
12 W. Church Street
Frederick, MD 21701
PO Box 2526
Waco, TX 76702
Pensco Trust Company
P.O. Box 26903
San Francisco, CA 94126
104 Congress Street
Portsmouth, NH 03801