Short Course on Funds – What You Need To Know

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 has to be regulated by written instructions and satisfy a few requirements which are related to contributions, holdings, and the trustee’s identity. 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 restriction on investor choice results from because IRA custodians being permitted to decide on the types of assets they will handle within the confines set by tax regulations. Majority of IRA custodians only accept investments in very liquid, easily valued products – for example, approved stocks, 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. 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 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 offered by an SDIRA have something to do with an account owner’s ability to use alternative investments in order to reach alpha in a tax-favored manner. At the end of the day, success in an SDIRA depends on the account owner’s unique knowledge or expertise meant to capture returns which, after bending for risk, exceed 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. Violating transaction rules can have harsh consequences, including the full IRA being declared as taxable by IRA at the beginning of the year when the illegal transaction ensued, meaning the taxpayer may have to pay deferred taxes plus a ten percent 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.