Insights into Investing with an SDIRA
By Christopher Levarek
"It's not how much money you make, but how much money you keep, how hard it works for you, and how many generations you keep it for."
- Robert Kiyosaki
The SDIRA - What is it?
The Self-Directed Individual Retirement Account or more aptly known SDIRA, is an account in which the investor is able to make all the investment decisions regarding the account funds. Rather than depending or relying on an account/fund manager in a third party company in a traditional IRA with traditional stock/bonds, the SDIRA allows the investor to choose alternative assets for investing. Investments can be made into private placements, private securities, real estate, precious metals and crowdfunding investments to name a few.
The SDIRA Custodian - Who?
Traditionally, the investor will align with a “custodian” or third partner company specializing in SDIRA to hold the fund or account however the investment decisions are in the investors control. Due to the complexities and regulations with an SDIRA, certain companies specialize in maintaining these accounts and traditional firms might not carry the SDIRA as an account option. Some example custodians known on the market as of writing this article would be:
Investing with an SDIRA - How does it Work?
So how does one invest with an SDIRA? Typically, investors choosing to use an SDIRA will have a current IRA or 401k that they roll into an SDIRA . This then allows them to use the SDIRA as a fund account for investing in all the non-traditional investment assets of their choosing going forward.
The investor working with their custodian finds an investment asset and then places an investment, using the SDIRA funds, in a project such as an apartment syndication or real estate acquisition. Each project will vary, however any ROI or returns will then go back into the SDIRA account. This then allows the investor to continue to use the capital funds on future investments.
Gotchas - What to know?
Disqualified Persons
The SDIRA can not be used to fund projects for persons to include:
Parents, grandparents, your spouse, your children, your grandchildren, and all of their spouses
Additionally, the disqualified persons can not offer goods, services, or facilities regarding the investment, ie. contractor work, real estate commissions, etc.
Personal Benefit
The SDIRA can not be used for providing personal benefit such as spending the funds on acquiring a new personal TV or car by transferring to personal account.
UBIT - Unrelated Business Income Tax
Investing with an SDIRA can be very beneficial due to the gains/returns not being taxed. However, the investment returns using a SDIRA can be subject to the UBIT, which is a tax that is due to an IRA when it receives “business income” as opposed to “investment income”.
An SDIRA investor will commonly pay tax on returns from SDIRA funds if :
The investment is in ownership of an LLC that operates by selling goods and services and is structured as a pass-thru entity. Business taxable income then filters down to the investor through K-1s.
The investment is used in short-term real estate flips or development deeming the investment as inventory or considered “non-investment assets”
The investment used leverage or financing to acquire the real estate property such as a non-recourse loan for 70% of the property value(the other 30% being the SDIRA and/or other investor funds). Thus 70% of the rental income would be subject to the UBIT taxes which will filter down to the SDIRA investor.
In Final
The SDIRA is a great vehicle for investing in real estate and other non-traditional investment assets which typically have higher yields then traditional stocks/bonds. It is important to truly vet the SDIRA custodian/holder and understand all the fee structures associated with the account. In addition, performing due diligence on the investment or asset to use with the SDIRA is always recommended. As always, Invest Smart!