Tax Consequences of a Self-Directed IRA

by Steve Lander

A self-directed IRA lets you funnel almost any type of investment into a traditional or Roth account. Instead of having a custodian give you a set of choices you can invest in, you direct your account's trustee to buy the assets you choose. You can sock away precious metals, real estate, business interests and other investments that usually wouldn't go into an individual retirement account.

Self-Dealing

"Self-dealing" refers to when you get something out of your IRA investments without actually withdrawing money. If you put a vacation property in your self-directed IRA and spend a week at it, you're self dealing. Working on your own property is another example, since that would be using your effort to create equity, rather than letting the property create its own equity. If you are involved in self-dealing and the Internal Revenue Service finds out, your IRA could be invalidated. It'll become a regular investment account, and you'll have to pay regular income tax on the whole account, plus a 10 percent penalty on everything there. So, if there's $100,000 in the account and you pay tax at 25 percent, you'll have to come up with $35,000 to pay off the tax and penalties.

Management Fees

If you choose to pay your account's management fees by a separate payment from outside your self-directed IRA, the fees may be tax-deductible. Because self-directed IRAs can have lots of fees, you may be able to write off a big chunk of money on your taxes. The IRS lets you do this as a part of your miscellaneous deductions on Schedule A. Miscellaneous deductions like investment management expenses and unreimbursed employee expenses can only be written off to the extent that they exceed 2 percent of your adjusted gross income.

Prohibited Investments

You can buy a lot of things in a self-directed IRA, but you can't buy everything. If you're into collecting stuff, don't do it in your self-directed IRA. For example, you can buy precious metal bullion, but you can't buy rare collectible coins. You also can't buy stock in an S corporation, so you won't be able to use your IRA to bankroll some new small business ventures. You can't buy life insurance contracts.

Contributions and Withdrawals

Self-directed IRA contributions and withdrawals follow the same rules as with regular IRAs. You can sock away $5,500 per year, or $6,500 if you're 50 or older, for the 2013 tax year. You can write off the money you put in a traditional self-directed IRA. You can put even more money in your self-directed IRA by rolling over money from another account. If the account holds real estate that needs repaired, you can't transfer money into the IRA to pay for them. If you pull your money out before you're age 59 1/2, you'll probably have to pay tax and a 10 percent penalty. The IRS will let you off the hook on the penalty if you have a good excuse, like buying your first home or certain medical bills. Once you're 59 1/2, you can start taking money out without penalties. When you reach 70 1/2, you have to begin taking money out of a self-directed traditional IRA.

About the Author

Steve Lander has been a writer since 1996, with experience in the fields of financial services, real estate and technology. His work has appeared in trade publications such as the "Minnesota Real Estate Journal" and "Minnesota Multi-Housing Association Advocate." Lander holds a Bachelor of Arts in political science from Columbia University.

Photo Credits

  • Polka Dot Images/Polka Dot/Getty Images