The Self Directed IRA for the Layman

The Self-Direct IRA

What is a self-directed IRA (SDIRA)?

Per Investopedia …

A self-directed individual retirement account (SDIRA) is a type of individual retirement account (IRA) that can hold a variety of alternative investments normally prohibited from regular IRAs. Although the account is administered by a custodian or trustee, it's directly managed by the account holder—the reason it's called "self-directed."

Available as either a traditional IRA (to which you make tax-deductible contributions) or a Roth IRA (from which you take tax-free distributions), self-directed IRAs are best suited for savvy investors who already understand the alternative investments and who want to diversify in a tax-advantaged account.

For a real estate investor, a SDIRA is a means to invest your IRA funds into real estate … actual real estate (not REITs). You can buy a rental property, invest in a syndication, invest in debt, etc. There are a number of other investment options as well, such as precious metals, commodities, tax lien certificates and others.

How do you create an account?

There’s not much to it. You select a custodian just like you would with a regular IRA, however, the commonly thought of custodians (Fidelity, TD Ameritrade, Charles Schwab, etc.) do not offer SDIRA options. Once you select your custodian you contact them, fill out some paperwork, transfer the funds from your old IRA to the SDIRA, and you are set. At this point you have the ability to invest these funds in real estate.

How do you actually do the investment?

This depends on whether you are setup with custodian control or checkbook control.

For custodian control: Once you select the investment, you provide the custodian with a few pieces of paperwork. You will typically kickoff the process by filling out a Direction of Investment (DOI) form, which is a short (1 page) document just letting them know that you intend to create an investment and you let them know the name and type of investment. Past that, it is providing the custodian with things like the PPM, Offering Memorandum, wiring instructions, etc. Once the custodian verifies that the investment doesn’t violate any SDIRA regulations they wire the money to the sponsor/general partner.

For checkbook control: Checkbook control is exactly what it sounds like. There is no custodian oversight and you can direct funds wherever you like via checks or wires. You need to make sure that you have a clear understanding of what constitutes a prohibited transaction. Beyond that, you fill out the normal paperwork for the sponsor as you would with a cash transaction and then you send them the funds.

How are the distributions handled?

Think about it from the standpoint of – your SDIRA owns the investment, not you. As such, all of the distributions go directly to the SDIRA.

Isn’t it bad to invest in tax advantaged assets inside a tax protected entity?

Normal tax disclaimer – I’m not a tax professional. Treat this advice as such.

Like most things … it depends. If you are relying on bonus depreciation to offset gains from another cash deal to justify the investment, then investing via your SDIRA will not help you. If you are investing in the deal because you like the returns vs. any other option you have with IRA money, then it’s a great idea.

What about UBIT?

Normal tax disclaimer – I’m still not a tax professional. Treat this advice as such.

I was going to go into the ins and outs of UBIT, but that is very googleable. But there is a quick and easy answer to avoid UBIT … use eQRP! I am not associated with eQRP in any way. They don’t even know that I’m posting this. eQRP is simply a better option than a ‘normal’ SDIRA. The way they are structured, they completely eliminate any possibility of UBIT. I am speaking as someone who has invested a significant amount of money through eQRP and who has recommended eQRP to countless individuals. Go to their website and give them a call to understand the details, but it is very easy. It also gives you checkbook control. The only downside is that they cannot handle beneficiary IRA’s. If you have a beneficiary IRA and want to invest it in real estate, you have to go with a ‘normal’ custodian. If this is you, this is a pretty good UBIT calculator …

https://ndtco.com/content/ubit-calculator

Also, (again – not a tax pro) I have been advised that one deal’s tax benefit within your SDIRA can offset the UBIT triggered by a separate deal within the same SDIRA account. So there is some strategy to your SDIRA investing. An investor could offset the UBIT from a leveraged deal with the depreciation from an unleveraged deal. There are very good unleveraged deals out there. Something to think about when you start your own SDIRA journey.

But my funds are tied up until I’m 59-1/2 right?

No. This is a mindset. It costs you more to access those funds prior to turning 59-1/2, but they are 100% accessible. Many view these funds as inaccessible, however, I would advise looking at what it would look like to pay the 10% penalty and potentially utilize the cashflow and see how that impacts your ability to reach financial independence. Some individuals have a tremendous amount of money in IRA’s and this could mean retiring at 50 instead of 60. Also, you don’t have to take it all out. You can just take out all or part of your monthly/quarterly distributions and leave the rest alone. This strategy would theoretically keep you from depleting that account, while still boosting your accessible cashflow.

Closing

Investing outside of the stock market through eQRP or a SDIRA can be an outstanding option. For those interested in getting away from the stock market and creating cashflow, it is worth looking into.