Depositaries of self-managed IRA accounts can help account holders avoid prohibited transactions, but they're not always obvious. The IRS is not likely to oversee an IRA holder's investments, so the agency depends on custodians to report prohibited transactions. The self-directed IRA allows the account owner to invest in alternative assets, such as real estate, promissory notes, and tax liens. If properly structured, these investments can produce significantly higher investment returns than those possible through investments available in traditional IRAs.
A brokerage agency for a regular IRA would send you a tax return every year. With a self-directed IRA, your tax preparation is, well, self-directed. You should also keep a record of what is allowed by the IRS rules. For example, you can't invest in a rental property where you live or in collectibles.
If you violate these rules, you may run the risk that your balance will become subject to one-time tax. Generally, if the owner of an IRA or other disqualified party makes a prohibited transaction, the IRA account loses its IRA status on the first day of the year the transaction took place. In addition to these more direct prohibited transactions, the IRS also prohibits investors from indirectly benefiting from their investment. A self-directed IRA allows you to explore unconventional areas of retirement investment while enjoying the tax-deferred growth that makes traditional IRAs so attractive.
The Jubilation Industry Trust Association (RITA), a self-directed trade group in the IRA industry, estimates that assets in these types of retirement accounts represent 3 to 5 percent of the total assets held in IRAs. Regulators have sued some self-directed IRA depositories for managing Ponzi schemes, tricking investors into investing in unregulated securities, committing other forms of fraud, and using investor funds for living expenses. Be sure to think critically about how you manage your IRA investments and be very careful not to. A self-directed IRA offers the same tax benefits as a traditional IRA, and they also come in a Roth variant.
To the extent that IRA assets are subject to unrelated business income tax or UBIT (for example, when there is income from debt-financed real estate or from an operating business), the account owner may need to file an income tax return for the IRA. In addition, those who are disqualified include your self-directed IRA service providers, such as the custodian of your choice, as well as your financial advisor, certified public accountant and lawyer. The Securities and Exchange Commission (SEC) published a bulletin for investors warning investors of the possible risks associated with investing through self-managed IRAs. The Forbes Financial Council is an invite-only organization accessible to executives from successful accounting, financial planning and wealth management firms.
The Securities and Exchange Commission (SEC) recently issued an alert to investors about the risk of fraud in self-directed IRAs. For example, if you know a lot about real estate, you might think it might be worth buying a building with your IRA. If these risks don't deter you, it's important to exercise due diligence when searching for a self-directed IRA depositary. Another important rule to follow when managing your self-directed IRA is to comply with the contribution limits set by the IRS.