Overview of Self-Directed IRA Rules and Regulations
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).
Differences between Self-Managed vs. Self-Directed IRA
All IRAs allow account owners to pick from investment alternatives possible under the IRA trust agreement, as well as to buy and sell those investments as the account owner desires, provided the sale proceeds will stay in the account. The restraint on investor choice springs from IRA custodians being allowed to pick the types of assets they will handle within the limits of tax regulations. Most IRA custodians only permit investments in greatly liquid, easily valued products, like bonds, ETFs and CDs, mutual funds, etc.
However, some custodians are willing to handle accounts that hold alternate investments and to equip the account owner with enough control to “self-direct” such investments within the limits of stax regulations. There is an expansive list of alternative investments, limited only by a few IRS prohibitions against illiquid or illegal activities under self-directed IRA rules, and a custodian’s willingness to manage the holding.
The most commonly cited example of an SDIRA alternative investment is direct ownership of real estate, which could involve redevelopment of a property or a rental case. Direct real-estate ownership strongly differs from publicly traded REIT investments, because the latter is often 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.
An overarching idea in self-directed IRA rules and regulations is that self-dealing, where the IRA owner or manager uses the account for personal profit or in a way that violates the intent of the tax law, is disallowed. The main elements of self-directed IRA rules and regulations and compliance are identifying disqualified individuals and the nature of transactions they cannot initiate with the account. The effects of violating transaction rules can be harsh, including the IRS declaring the whole IRA as taxable at its market upon the beginning of the year in which the forbidden transaction happened, meaning the taxpayer may have to pay old deferred taxes on top of a 10% early withdrawal penalty.
Besides the IRA owner, self-directed IRA rules describe a “disqualified person” as anybody who controls the assets, disbursements and investments and receipts, or those who can affect investment decisions.