Yahoo Finance Experts: Why You Shouldn’t Put Unconventional Investments in Your IRA
Individual retirement accounts (IRAs) offer fantastic tax advantages. But that means you should be more strategic about what you put in an IRA — not less so. Not every asset is a great fit for your IRA, and some you can’t own under a self-directed IRA (SDIRA) by law.
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Before you try to put your bullion or bitcoin in your IRA, consider the following risks and downsides to putting unconventional assets in an IRA.
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Prohibited Items
Uncle Sam doesn’t let you put anything you like in a self-directed IRA. More specifically, the IRS doesn’t let you hold life insurance policies or collectibles in your IRA or other qualified plan.
Collectibles include not just obvious items like baseball cards but also art, gems, wine, antiques and even some coins and precious metals — though you can typically invest in gold and silver if you work with a specialist custodian.
You also can’t make certain types of derivative trades with unlimited or unspecified risk, such as ratio spreads or naked call writing.
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Prohibited Transactions
Just because the IRS lets you hold an asset type in your IRA doesn’t mean you can do whatever you want with it.
Take real estate for example. You own investment properties or private equity real estate investments in a self-directed IRA. But you can’t use IRA assets for your own personal benefit.
That means you can’t use your IRA to own a vacation home that you sometimes rent out, or a home that you house hack.
You also can’t transact with a disqualified person, including spouses, parents, children and grandchildren. For that reason, you can’t own an investment property with your IRA and rent it out to your college-age daughter, or sell it to your spouse.
Read up on other prohibited transactions before getting too clever with your IRA investments.
SDIRA Fees
In today’s world, most brokerages offer free opening and ownership of standard IRAs. However, the same can’t be said for self-directed IRAs.
Custodians charge money to hold your alternative assets in an SDIRA. And not trivial amounts, either — you should expect to pay hundreds of dollars each year. Depending on your balance, that could amount to a high percentage. Imagine earning an 8% return on your alternative investments, only to hand over 4% to the custodian.
Confusing Compliance Rules
The rules governing SDIRAs aren’t always intuitive or obvious.
Nicole Lehman of Clever Real Estate offers the following example: “Imagine you save up tens of thousands in your IRA to use as a down payment for a rental property. You manage to find a lender willing to provide a non-recourse mortgage — a requirement for properties in an SDIRA — and buy the property.”
But, she says, “When you report earnings to the IRS, you have to break down the percentage of the property funded by your IRA — the down payment — versus the lender.” According to Lehman, this means you only get IRA tax benefits on the portion funded by your IRA.
For an instant headache, look up the IRS rules on unrelated business income tax (UBIT).
Assets With Existing Tax Benefits
The whole point of investing with an IRA is tax benefits. But some assets already come with their own baked-in tax advantages.
Take real estate, for example. Investors can already write off all conceivable expenses, including mortgage interest. They can also write off some less obvious items, such as depreciation.
Final Thoughts
You could potentially eke out a little extra tax advantage by investing in real estate with a self-directed IRA. Or you could use your IRA to invest in assets (like stocks) that don’t come with intrinsic tax advantages.
Your investment portfolio will almost certainly include stocks, after all. So why not keep your life simpler and cheaper by holding some of your stock portfolio in your qualified retirement accounts? Let your real estate investments stand on their own tax benefits.
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