Thinking of a Self-Directed IRA (Part 1)

Introduction: The popularity of investing retirement accounts into “non-traditional” assets (e.g. real estate, private lending, and everything else you can imagine) using a self-directed IRA or an IRA-owned LLC (“checkbook control” IRA) has increased rapidly, perhaps too rapidly, since the economic meltdown in 2008. This growth has brought increased mainstream media attention, scams, and a huge amount of legal and tax non-compliance.

The unfortunate reality is that most self-directed IRA account holders do not receive a sufficient amount of

legal/tax education prior to investing. The reasons for this include: (1) the account holder’s normal “gatekeepers” (e.g. attorneys, accountants, financial advisors) are either unfamiliar with the rules or are kept completely in the dark because the account holder is afraid that their advisor will not approve; (2) the account holder receives incorrect or misleading information on the internet; (3) information is provided by representatives/salesman of IRA custodians or IRA LLC facilitators who are financially motivated to “sell” the particular self-directed IRA product that their employer provides; and (4) the IRA custodians and IRA LLC facilitators are not legally representing the IRA account holder (nor are they trained to do so), but rather providing “casual information”.

All of the confusion and misinformation has lead me to create the following top 3 reasons why an IRA account holder should speak with a tax attorney before forming a self-directed IRA (or IRA LLC):

1. Not all IRA custodians (and self-directed IRAs) are created equal. Two initial issues that should be carefully considered by a retirement account owner prior to setting up a self-directed IRA are: (1) “what custodian should I use” – there are actually a lot more of these custodians out there than you might think; and (2) “will the IRA invest directly or through an IRA-owned LLC structure”? Failure to consider these issues and rashly transferring funds to a particular custodian because “my neighbor uses them” can lead to administrative hassle, unnecessary fees, and other problems. Call 1-866-225 1786 for more information:

The fee structure of self-directed IRA custodians can vary dramatically, for example: some charge higher setup fees and lower revolving fees; some charge fees based on the IRA’s value; some charge fees based on the number and type of assets owned by the IRA; some charge fees when the IRA pays an expense, receives income, and/or custodian action is required in any way; and some even charge fees for “research” and account termination. In addition, the amount of “compliance” paperwork that is required when the IRA executes a transaction varies significantly between custodians – which, when an investment requires immediate action (e.g. real estate foreclosure auction), can be the difference between the IRA purchasing the asset or missing out on an opportunity. In short, no two custodians are exactly alike, so a thorough vetting based on the account holder’s likely IRA investment is essential.

Which custodian is the best fit for a particular account owner depends on the type of investments that will be made and the corresponding involvement of the custodian going forward. For example, purchasing rental real estate within a self-directed IRA is a very popular type of investment, but also leads to expenses that must be paid by the IRA (e.g. property taxes, insurance, maintenance and improvement costs, and possibly mortgage payments). The IRA custodian’s procedure for dealing with these expenses (and the transaction fees the custodian charges for this service) is a very important issue that should be considered by the IRA account holder before setting up an IRA.

Finally, if the IRA account holder chooses to gain the maximum amount of control by setting up an IRA-owned LLC, the account holder will generally want to pick a very low cost custodian. The reason for this is that the custodian will not be involved in the day-to-day investment decisions, which instead will be made at the “LLC level.” In short, why pay a custodian high fees to do almost nothing?