by Most IRAs hold the same few things: mutual funds, ETFs, and maybe some bonds. That’s a sound strategy, but it isn’t your only option.
A self-directed IRA (SDIRA) lets you invest retirement money in real estate, private companies, precious metals, and other assets your brokerage won’t touch. You get more control over where your money goes. You also take on more responsibility.
Here’s how an SDIRA works, the rules you can’t ignore, and five steps to open one.
What You Can (and Can’t) Hold in an SDIRA
An SDIRA opens the door to alternative assets, but it plays by the same basic rules as any IRA.
You can’t invest in: collectibles such as art or rare coins, or life insurance. Avoid those, and you’ve already won half the battle.
Earnings stay inside the account. You can’t withdraw dividends from a traditional IRA without penalty before age 59½, and the same goes for an SDIRA’s earnings. Rental income, sale proceeds, and dividends all flow back into the IRA, not your personal bank account. The SDIRA also needs its own separate banking or investment accounts.
You can’t benefit personally. You and close family members can’t live in, vacation at, or otherwise use property your IRA owns. You also can’t put sweat equity into it. Even replacing a faucet in an SDIRA rental requires hiring a contractor.
Debt can trigger extra tax. If your IRA buys property with a mortgage, the share of income tied to that debt may owe unrelated business income tax (UBIT).
You Don’t Have to Figure It Out Alone
Taking full control of your investments can feel intimidating, especially after years of letting a fund company make the decisions. With an SDIRA, you choose every investment.
Help is out there. Online resources and support groups cover the rules in detail, and a good custodian will answer your questions. We’ve found ours extremely helpful, and they hold monthly online workshops where we can submit questions.
Step 1: Choose Your Structure, Then Your Custodian
Custodian-controlled or checkbook control?
Your first decision is who handles transactions: your custodian, or you.
For real estate, checkbook control gives you an edge. If you find a cash deal and need to act fast, you can wire money and close within hours.
Hours? Doesn’t closing take 30 to 45 days?
Not with unusual deals like county real estate auctions.
Checkbook control can also save you money if you buy and manage rental properties, since some custodians charge for every transaction they process. And you won’t need their approval for each purchase, which can delay a fast-moving deal.
How checkbook control works
To get checkbook control, you set up a limited liability company (LLC) owned by your IRA, often called a self-directed IRA LLC. Set it up correctly. Mistakes can lead to penalties and unwanted distributions.
Picking a custodian
You can use an existing IRA custodian or open an account with a new one. If you plan to invest in real estate, an LLC structure with checkbook control is often the best fit.
Compare fee structures carefully. Some custodians charge a flat annual maintenance fee plus occasional wire fees, which can cost far less than fees based on your account size. Look at investment options and customer service, too. There are many custodians to choose from, so take your time.
Step 2: Set Up Your Account
Once you pick a custodian, setup is usually simple: fill out the paperwork and provide identification documents. Read the fine print before you sign so you don’t get stuck with hidden fees or restrictive terms.
Step 3: Fund Your Account
Transfer money from an existing IRA or make a new contribution. Your custodian will provide the transfer forms.
One warning: don’t take a distribution and mail your new custodian a personal check. That can make the money taxable and penalized instead of rolling it over.
Step 4: Invest Your Money
This is where the fun (or frustration) begins. Research investments that fit within SDIRA rules.
In a hot real estate market, good deals can take a while to find. Wait for the right one. If you have other investments in mind, you may be able to invest right away.
Step 5: Monitor and Adjust
Keep an eye on your investments to make sure they’re performing as you expected, and adjust as your goals or the market change.
Each year, you’ll also give your custodian a year-end valuation of the account, which they report to the IRS for you.
The Biggest Objection, Answered
When I first started researching real estate in an SDIRA, I worried it was the worst investment sin I could commit. I found plenty of naysayers, which made me want to dig deeper.
Many critical articles come from financial advisory firms or from writers who’ve never held an SDIRA. An advisor has little reason to encourage you to manage your own money.
The most common objection raised is that you can’t deduct property expenses like repairs or property taxes or depreciate the property against your personal income.
That’s true. But it’s equally true of every retirement account. You can’t deduct losses on mutual funds in your traditional IRA, and you can’t harvest tax losses there either. Inside the IRA, expenses are paid from the account and reduce your gains, so you’re only taxed on what you eventually withdraw.
In short, an SDIRA gets the same tax treatment as any other IRA. In a traditional SDIRA, your money grows tax-deferred, and in a Roth SDIRA it grows tax-free. Rental income can be reinvested within your retirement accounts without adding to your tax bill.
Who Should Consider an SDIRA
For FIRE readers, an SDIRA makes the most sense for early retirees who want more real estate exposure but have most of their money in traditional IRAs. It can also lock in some market gains by moving part of your pre-tax savings into tangible assets, so not all your eggs sit in the stock market basket.
It’s not for the average 401(k) investor. You’ll need to learn the rules, and it takes more time than buying a mutual fund. Your custodian can help, but the decisions are yours.
If you’re still working and building wealth, keep it simple: a 90% stock, 10% bond allocation is probably your best bet. Work, invest, and repeat until you reach financial independence.
Final Thoughts
If you’d rather not direct your own investments, a traditional retirement account is the way to go. If you want more control or more tangible assets, an SDIRA is a real option, and you don’t have to go all in. You can start with a small slice of your portfolio.
