Self-Directed IRAs and Alternative Investments

Learning Objectives

Learn the fundamental concepts of self-directed IRAsDiscuss the types of assets that are considered alternative investmentsExplore guidance on how to value and report alternative investmentsUnderstand the basic concepts of prohibited transactions and UBTI

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What Is a Self-Directed IRA?

A personal savings account that allows individuals to contribute annually for their retirement savings. It provides either a tax-deferred or tax-free way of saving for retirement.

There are many different types of IRAs, though Traditional and Roth IRAs are the most common. A self-directed IRA allows individuals to invest in traditional and non-traditional assets.

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Standard IRA vs. Self-Directed IRA No tax law differential between standard IRA and self-directed IRA.

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Standard IRALimits IRA investments to the traditional investment options the financial planner and/or investment advisor set for the plan.

Self-Directed IRAAllows for alternative investment options.

Why Would Someone Want a Self-Directed IRA?

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Portfolio diversification and greater control of

investments

Availability of alternative

investments

Familiarity with certain types of

investments

Self-Directed IRAs

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Low cost/reasonable fees

Self-Directed IRA Establishment Process

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Step 3Funds Transferred

Step 1Investment and

Custodian Identified

Step 5Monitor and Maintain

Investments

Step 4Asset Purchased

Step 2Open the

Self-Directed IRA

Step 1: Identify an Investment and a Custodian

• Factors to consider– Level of service– Ease of account requests through online and mobile processes– Cost– Role of financial advisor

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Step 3Funds Transferred

Step 1Investment and

Custodian Identified

Step 5Monitor and Maintain

Investments

Step 4Asset Purchased

Step 2Open the

Self-Directed IRA

Step 2: Establish the New Self-Directed IRA

• Open the self-directed IRA– Follow the procedure of the IRA custodian– Similar to establishing a standard IRA

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Step 3Funds Transferred

Step 1Investment and

Custodian Identified

Step 5Monitor and Maintain

Investments

Step 4Asset Purchased

Step 2Open the

Self-Directed IRA

Step 3: Move Funds to the Self-Directed IRA

• Methods– Transfer or rollover from another IRA– Rollover from an eligible retirement plan such as a 401(k), 403(b), or

governmental 457(b) plan– Annual contributions

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Step 3Funds Transferred

Step 1Investment and

Custodian Identified

Step 5Monitor and Maintain

Investments

Step 4Asset Purchased

Step 2Open the

Self-Directed IRA

IRA-to-IRA Transfer of FundsTax-free movement of assets between like IRAs• No IRS reporting• No constructive receipt • No time or frequency restrictions• No income tax withholding• No value restrictions

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Step 3Funds Transferred

Step 1Investment and

Custodian Identified

Step 5Monitor and Maintain

Investments

Step 4Asset Purchased

Step 2Open the

Self-Directed IRA

Previous IRA Custodian

Self-DirectedIRA Custodian

IRA-to-IRA Rollover of FundsTax-free movement of assets between like IRAs• Reportable to the IRS• Constructive receipt• 60-day rollover rule applies • 1-per-12-month rule applies• No value restrictions

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Step 3Funds Transferred

Step 1Investment and

Custodian Identified

Step 5Monitor and Maintain

Investments

Step 4Asset Purchased

Step 2Open the

Self-Directed IRA

Previous IRA Custodian Self-Directed IRA Custodian

60-day restriction

Retirement Plan Rollover-to-IRATax-free movement between employer-sponsored retirement plan and IRA• Reportable to the IRS• Constructive receipt• 1-per-12-month rule does not apply• May be rolled over directly or indirectly• For indirect rollovers

- 60-day rollover rule applies- 20% mandatory federal tax withholding

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Step 3Funds Transferred

Step 1Investment and

Custodian Identified

Step 5Monitor and Maintain

Investments

Step 4Asset Purchased

Step 2Open the

Self-Directed IRA

Eligible Employer Retirement Plan

Self-Directed IRA Custodian

Direct Rollover

Indirect Rollover

Step 4: Make an Investment

• Asset purchased• Investment identified by IRA owner or advisor• Choose investments carefully to avoid prohibited transactions

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Step 3Funds Transferred

Step 1Investment and

Custodian Identified

Step 5Monitor and Maintain

Investments

Step 4Asset Purchased

Step 2Open the

Self-Directed IRA

Common Alternative Investments

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Step 3Funds Transferred

Step 1Investment and

Custodian Identified

Step 5Monitor and Maintain

Investments

Step 4Asset Purchased

Step 2Open the

Self-Directed IRA

Farm and Ranch Real EstateHedge Funds

Limited Liability Companies

Oil, Gas,and Mineral Rights

Stock Not Traded on Established Market

Loans and Notes

Certain Investments Not Allowed in IRA

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Step 3Funds Transferred

Step 1Investment and

Custodian Identified

Step 5Monitor and Maintain

Investments

Step 4Asset Purchased

Step 2Open the

Self-Directed IRA

Collectibles S-Corp StockLife Insurance

Step 5: Monitor and Maintain Account

• Monitor and maintain investments• Considerations include

– Valuation of IRA assets– Unrelated business taxable income (UBTI)– Asset “maintenance” (e.g., real estate)– Prohibited transaction monitoring and reporting

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Step 3Funds Transferred

Step 1Investment and

Custodian Identified

Step 5Monitor and Maintain

Investments

Step 4Asset Purchased

Step 2Open the

Self-Directed IRA

Hot Topics and Myths

• Self-directed IRAs are complicated to navigate

• Self-directed IRAs are expensive to maintain

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Who Is Responsible for Valuation?

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Trustees/Custodians

IRAs

Limited Guidance

Establish Own Procedures

Hot TopicsValuing IRA Plan Assets

• How to determine the FMV of an alternative investment

• All plan assets need to be valued– Annually, for Form 5498

FMV reporting– For RMD purposes– When a distribution occurs

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Determining Common Alternative Investment FMV Examples

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Private Loans/Promissory Notes– Outstanding principal balance of the loan, plus any accrued interest

Private LLC– Cumulative value of all LLC assets plus cash balances held in an

account under the LLC’s name – Third-party LLC valuator also can provide an analysis of the overall value

Real Estate– Appraisal– Comparative market analysis or broker price opinion

Yes. • IRC Sec. 408(i)• Treas. Reg. §1.408-5• Interpretive Letter EP:R:9

(“Riddle Letter”)• OCC Handbook

It’s hard to value,

so do I have to do it

every year?

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How Are IRA Alternative Investments Reported?

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Enter asset code(s)

Enter FMV of hard-to-value asset

Alternative Investments Reporting Form 5498 Codes

A – Stock or other ownership interest in a corporation that is not readily tradable on an established securities market

B – Short- or long-term debt obligation that is not traded on an established securities market

C – Ownership interest in a limited liability company or similar entity (unless interest is traded on established securities market)

D – Real estate

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Alternative Investments Reporting Form 5498 Codes

E – Ownership interest in a partnership, trust, or a similar entity (unless interest is traded on an established securities market)

F – Option contract or similar product that is not offered for trade on an established option exchange

G – Other asset that does not have a readily available FMV

H – More than two types of assets (listed in A through G) are held in this IRA

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Alternative Investments Reporting Form 1099-R

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Form 1099-R Requirements

Hot TopicsUnrelated Business Taxable Income (UBTI)

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Main purpose of IRA is to generate investment income

Certain IRA investments can trigger UBTI and cause taxation as a business entity

Investments that cause IRA to engage in activities not related to IRA’s main purpose

IRS Form 990-T required for UBTI in excess of $1,000

UBTI Example

Jim used his Traditional IRA to purchase the Bluebird Café. The café generated $155,000 of UBTI. ABC Financial Organization as the IRA custodian, must file Form 990-T, and pay any taxes that are due from Jim’s IRA. Jim cannot file the 990-T or pay the taxes due personally.Questions:1. Is Jim allowed to purchase or invest in a business

with his self-directed IRA assets?2. What are some important considerations if he does?

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UBTI is paid directly from the IRA

Financial organization files and pays tax using IRS Form 990-T

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Hot TopicsUnrelated Debt-Financed Income (UDFI)

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Subset of UBTI May apply when debt or leverageis used to buy

an IRA investment

• Leveraged real estate• Purchasing securities

on margin• Limited partnership or

REIT investments that use leverage

UDFI and Real Estate Purchase Example

Jenny buys a $200,000 rental property with her IRA. The average value of her mortgage for 2019 is $100,000. Jenny received $20,000 in rental income in 2019. Because her average debt was 50% of the property purchase amount, 50% of the rental income ($10,000) is considered UDFI for the year, and is taxed at trust tax rates.

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Generally occur when an IRA asset is involved in a transaction with a disqualified person or party

Prohibited Transactions

for the benefit of the IRA.Scenario: Ellen’s IRA purchases a piece of rental property.She personally owns a construction company outside of her IRA.Ellen uses her construction company to do work for her IRA’s rental property.

Result:Using the personally owned assets or contributing sweat equity are considered prohibited transactions.

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Prohibited Transaction Example

Self-directed IRA owners use personally owned assets

Disqualified Parties

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What and who is a disqualified party?

Entities or people with whom an IRA must not conduct transactions.

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Ancestors/Lineal Descendants

IRA owner’s grandparent

IRA owner’s parent

IRA owner’s child (and child’s spouse)

IRA owner’s grandchild (and grandchild’s spouse)

IRA owner (and IRA owner’s spouse)

Disqualified Parties

Self-Directed IRA Example

Alternative InvestmentsJack has a $300,000 cash balance in his IRA. He wants to lend that money to his best friend’s start-up company.

Is this transaction permissible?

What concerns and considerations arise with this type of investment?

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Self-Directed IRA Example

Alternative InvestmentsEve has a $100,000 balance in her self-directed IRA.

She wants to use that money to buy a rental property that her mother currently owns.

Is this a prohibited transaction? Why or why not?

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Self-Directed IRA Example

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Alternative InvestmentsJoan has a Roth IRA with a balance of $1,000,000. She wants to invest $300,000 in a limited partnership investment and $400,000 into undeveloped land in California.

What are some possible considerations with a limited partnership investment?

How about with an investment in undeveloped land?

Questions?

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Self-Directed IRAs and Alternative Investments

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