Self directed retirement plan types

Self directed retirement plans came onto the scene in 1974 when the Employee Retirement Income Security Act (ERISA) created IRA and 401(k) plans.

Although these retirement plans introduced new asset classes that investors could purchase and hold, the Investment management companies that implemented the IRA and 401(k) programs only provided access to the existing Wall Street fare of Stocks, Mutual funds, and Bonds.

In 1962 the self directed Solo 401(k) retirement plan was created to benefit small business owners. 

All of the self-directed retirement plans were affected by the 1997 Taxpayer Relief Act that gave investors access to new asset classes inside their tax-advantaged retirement savings plans.

Income-producing real estate, Precious metals, raw land, Crypto, Limited Partnerships, Tax Liens, and even startup companies became IRS-approved asset classes for both tax-deferred and tax-exempt Investment.

These options gave investors new ways to diversify their Investment Portfolios outside of Mutual funds, Stocks, and Bonds.

Obviously, esoteric assets like tax liens and startup companies are not smart Investment choices for investors without specialized knowledge.

Precious metals and income-producing real estate, on the other hand, are asset classes that a wider range of investors can benefit from.

In this article we focus on owning real estate and physical Precious metals inside Self-directed IRAs.

Self-directed IRA rules

Self-directed IRAs have desirable benefits but they also represent a potential risk.

If we fail to follow the rules the IRS may disqualify the IRA and disallow any tax benefits the IRA might have provided. Obviously the financial consequences from such an event could be significant.

Precious metals IRAs

With Traditional and Roth Precious metals IRAs the risk of IRS disqualification is minimal because third-party Trustees and Custodians maintain possession of the retirement assets and satisfy all of the IRS-mandated requirements.

Passbook IRAs for Precious metals have an elevated risk of being disqualified because the investor takes over the role of both Trustee and Custodian with a self-created LLC. Any procedural misstep with the LLC or the handling of the IRA could give the IRS grounds for disqualification.

Income-producing real estate

Rental real estate can be a lucrative Investment vehicle when purchased and managed within an IRS-approved retirement savings plan. Investors can reap the historic benefits of residential income properties and use tax-advantaged savings to do so.

While the benefits of real estate investing are certainly worth pursuing, the risk of violating IRS guidelines is elevated with this asset class.

The key rule to understand is that beneficiaries of the IRA and close family members (“disqualified persons”) are not allowed to live in or work on the property. All transactions involving the IRA-owned real estate must be performed at arms-length.

The IRS specifically prohibits disqualified persons from making any repairs or improvements on the property because this “sweat equity” adds value to the property that would otherwise have to be paid for (look into IRS guidelines on “self-dealing” for more details on this obscure rule).

For example, if a tenant calls on Sunday morning and says that water is standing in all of the property’s sinks and bathtubs, the IRS prohibits anyone involved with the IRA from making repairs. The simple act of using a $6 plunger on a stopped-up drain could cause the entire IRA to be disqualified by the IRS.

Because of this restriction on disqualified persons it is likely that the cost to maintain IRA-owned real estate will be higher than it would be for identical property owned outside a tax-advantaged vehicle.

In an ideal retirement Portfolio any IRA-owned real estate would be fully managed by a property management company.

Although the management service increases the cost of owning the property, it makes it clear to the IRS that the “hands-off” rule is being followed in regards to the Investment. It also ensures that the tenants will be calling someone else on Sunday morning.

Self-directed IRA Real Estate

Let’s consider some real estate investing basics that change when we use tax-advantaged funds.

Purchase

The mechanics of purchasing rental real estate are identical whether we are using a SDIRA, a mortgage loan, cash, or some combination of those funds.

We first find an appropriate property to invest in, put the property into escrow, perform our due diligence on the property, and then provide the funds needed to close escrow.

The IRA wires funds into the escrow account and subsequently becomes the outright (or proportional) owner of the property.

The IRS is quite flexible about the funds used to close escrow. It is OK to combine multiple IRAs, use non-IRA funds, or even use funds contributed by disqualified persons. Mortgages are acceptable as well but they must be non-recourse loans (explained below).

Who owns the property

Ownership of the property is proportionately divided based on the funds used to close escrow. If the IRA purchased the property outright then the IRA would have 100% ownership.

In a more complex situation property ownership might look something like this:

Mortgage loans

Mortgages can be used to purchase real estate within an IRA but the loans have to be non-recourse.

With a non-recourse loan the lender can only take action against the asset that underlies the loan. The lender has zero recourse against any other asset in the IRA or against the investor as an individual.

Because the lender has limited recourse they will require a 40 to 50% down payment on the property. They are also likely to charge higher origination fees and a higher interest rate than would be the case with a recourse mortgage.

Using a mortgage inside an IRA creates taxable income for the IRA according to the IRS (Section 514 of the IRC). This tax must be paid by the IRA and obviously it represents an expense that will reduce the IRA’s overall returns.

Management

As discussed above, there is a risk of having our IRA disqualified by the IRS if we try to take on the role of landlord and handyman for the IRA-owned property.

Ideally we will turn these roles over to a property management company and maintain a 100% hands-off policy towards the Investment.

Property management and maintenance expenses will be paid by the IRA in proportion to the IRA’s ownership.

Tax bennies

Rental income from the property accrues within the IRA in a tax-advantaged manner.

These funds can be used to acquire additional property or the investor could receive the rental income as a distribution from the IRA (after age 59 ½).

Property flippers might find Self-directed IRAs for real estate particularly valuable because capital gains from a sale are not taxed in the year of the sale. Instead, the gains are either tax-exempt in a Roth IRA or tax-deferred in a Traditional IRA. In either case, 100% of the profit from the flip is available for the next property purchase. 

Real estate IRA companies

There are a limited number of real estate IRA companies to choose from. You can start your comparison shopping with the companies below and then look for competitors.

Check out the services each company offers and the fees they charge.

Take advantage of any educational material they provide and request a free information kit or consultation if you want to learn more.

How does a Gold IRA work

These simple steps allow us to open a Precious metals IRA:

Once the Gold IRA is setup there is nothing to do until it is time to take distributions after age 59 ½. At that point we can convert the Precious metals back into cash or, if we don’t need income, have the Custodian mail us the physical metal.

The ability to take distributions as physical metal allows investors to build a Portfolio of physical Gold and Silver inside their tax-advantaged accounts and then take personal possession of that metal in retirement.

The metal can then be sold as needed for income or gifted as desired (following all applicable IRS guidelines, of course).

Self-directed IRA fees

All IRAs involve setup fees and annual management fees whether they are SDIRAs or not. Management companies charge fees for the products they offer and IRAs are no different.

Real estate and Precious metals IRAs add another fee to cover transaction costs, whether the transaction is a purchase or a sale.

Gold IRAs

Precious metals IRAs are subject to more fees than other types of IRAs because someone (the Custodian) has to store physical metal in an IRS-approved facility.

In addition to the management and transaction fees for the IRA, there is a storage fee for the metal.

Real estate IRAs

Income-producing real estate requires management and maintenance. Those expenses can be thought of as a Self-directed IRA fee when we are doing our retirement planning.

We will pay this property management fee to a management company while the IRA management fee and transaction fees are paid to the IRA Trustee.

Self-directed IRA companies

In the table below we provide several candidate SDIRA companies for Precious metals.

All of these companies have knowledgeable representatives who can answer your specific questions.

Conclusions

In this brief article we focused on two types of self directed retirement plans, one for Precious metals and the other for income-producing residential real estate.

These alternative Investments allow for diversification of a traditional retirement Portfolio without causing any tax consequences (when done correctly.)

For more information about owning Silver and Gold inside your IRA, grab your copy of the free Gold Investment Kit.

To learn more about maximizing the tax benefits of owning real estate visit the IRS Real Estate Tax Center.

Browse the website to learn more about tax-advantaged investing, Self-directed IRAs, and the Precious metals.