John R. Bullis: Self-directed IRAs have some distinctive rules
A self-directed IRA allows the account owner to make investment decisions. Certain transactions and investments are prohibited. IRAs can invest in a wide variety of assets. Most IRA custodians limit what a taxpayer may purchase. The self-directed IRA is used to invest in items most custodians do not offer or allow.
IRAs generally cannot invest in life insurance contracts or collectibles. Investing in metal and coins is prohibited, but certain U.S. gold, silver and platinum coins and certain precious-metal bullion are allowed as investments.
Many self-directed IRAs invest in real estate and business ownerships.
Investing in real estate can result in changing from long-term capital-gains-tax rates to ordinary income resulting in higher tax rates when distributions are done. The tax expenses for depreciation, property taxes and mortgage interest are basically lost if the real estate is owned by a self-directed IRA.
Also, the self-directed IRA does not get a “step up” in tax basis on the death of the IRA beneficiary or owner. Hopefully the investment in real estate will increase in value and hedge against future inflation. If it is owned at death, the heirs get the “step up” in tax basis to value at death and the appreciation from purchase to death is not taxed to anyone! But is it is owned by a self-directed IRA, there is no “step up” in tax basis.
Investing in business ownership also converts long-term capital gains into ordinary income on distribution to the beneficiaries (owner or heirs).
It is important to consider the prohibited transactions. If there is any self-dealing between the account holder and the IRA, it can result in the total account being deemed as distributed. That would put the entire value taxed as ordinary income at the time of the prohibited transaction. If the owner is less than 59½ years old, the early-withdrawal penalty of 10 percent also may apply.
The prohibited transactions include the IRA conducting a transaction with a prohibited person. A prohibited person includes transactions the IRA has with the account holder; someone who exercises discretionary authority in managing or administering the IRA or its assets; anyone who provides investment advice for a fee; or a person who provides services to the plan; an employer and a corporation, partnership, trust or estate in which the account owner has at least 50 percent of the voting power.
Prohibited transactions include borrowing money from it; selling property to it; leasing property from it; buying property for personal use with the IRA funds; accepting unreasonable compensation for managing it; and using it as security for a loan.
Did you hear? “A wise man is never as sure of anything as a fool is of everything.”
John Bullis is a certified public accountant, personal financial specialist and certified senior adviser who has served Carson City for 45 years. He is founder emeritus of Bullis and Co. CPAs.