Self-Directed IRA Myths

There are so many pervasive myths surrounding what is and isn’t allowable with self-directed IRAs that it’s important to take the time in debunking them. To do just that, read on.

Myth #1: Buying any assets besides mutual funds, sticks, bonds, CDs or annuities is not allowed with an IRA.

The Facts: “Collectibles” and investments in life insurance contracts are actually the only prohibitions contained in the Internal Revenue Code for IRAs. That leaves open the opportunity to purchase anything else that can be documented including real estate, options, first and second liens against real estate and even secured and unsecured notes.

Myth #2: The only IRAs that can be self-directed are Roth IRAs.

The Facts: There are actually seven different types of accounts which can be self-directed and even combined to purchase a single investment. They are the 1) Roth IRA, 2) the Traditional IRA, 3) the SEP IRA, 4) the SIMPLE IRA, 5) the Individual 401(k), including the Roth 401(k), 6) the Coverdell Education Savings Account (ESA, formerly known as the Education IRA), and 7) the Health Savings Account (HSA).

Myth #3: It’s possible to make too much money or work for an organization to disqualify someone from owning a self-directed Roth or Traditional IRA.

The Facts: Almost anyone can have a self-directed account of some type! Of course, there are certain limits for contributions, having a work retirement plan or being of a certain age does not preclude you from owning an IRA either.  In fact, any person who has earned income and is under the age of 70.5 years can contribute to a Traditional IRA. What’s more, there are no income limitations for Traditional IRAs.

Myth #4: If I am self-employed and file a Schedule C for my income, I can’t have a self-directed 401(k) plan for my business.

The Facts: You can have a self-directed SEP IRA, a SIMPLE IRA or a 401(k) plan if you are self-employed and file your income on Schedule C of your personal tax return.

Myth #5: It’s not worth having a self-directed IRA because I can only contribute small amounts.

The Facts: Small accounts can reap the benefits of self-direction too. For example, small balance accounts can be pooled together with other investor accounts to participate in real estate investment. In fact, there are four manners in which small account holders may invest in real estate. These are: 1) Wholesaling of property, 2) Buying an option on real estate, 3) Purchasing property in your IRA subject to existing financing or with the borrowing of money from a bank, motivated seller or other hard money lender, and 4) Purchasing property as a partner with other IRA or even non-IRA investors.

Myth #6: I must establish an LLC which my IRA will own before purchasing any non-traditional investments with said IRA.

The Facts:  In spite of the urging of many firms to do so and their charging upwards of thousands of dollars to complete such a task, this is simply not true.

Myth #7: I can take a loan from my IRA to buy myself a vacation home.

The Facts: Unfortunately, the IRS is quite clear about IRA owners not being able to use assets of a plan in a manner which benefits the plan itself and not the IRA owner (other than as a beneficiary of the IRA) or any other disqualified person.

Myth #8: I can borrow funds from my self-directed IRA to buy real estate and then infuse any profits back into the IRA afterwards.

The Facts: The money used from the IRA for the purchase of property never actually leaves the IRA. What happens is an exchange of cash for the real estate by a custodian of the account. The IRA ultimately owns this real estate asset, meaning not only do all expenses associated with the asset need to be paid by the IRA, it also means that all profits resulting from that IRA-owned investment belong to the IRA and this includes rents received and gains from the sale of the asset.

Myth #9: An IRA cannot buy any real estate with debt and all purchases by the IRA must be made in cash.

The Facts: Not only can an IRA own debt-financed property, you can actually do more with debt-financing than you can without it.

Myth #10: An IRA is prohibited from owning a business.

The Facts: Again, so long as the investment isn’t self-serving, a self-directed IRA can own just about anything, including a business. That means that you cannot work for a business that is owned by your IRA. It is worth noting that if your IRA does own any interest in a business, either directly or indirectly, the IRA might actually owe what are called Unrelated Business Income Tax (UBIT) on its profits from the business.