The Seven Deadly Sins of Self-Directed IRA Investing
1.) Paying too much. Experienced investors will tell you: Make your money when you buy. Not when you sell.
This means that whatever the investment, the best investors are buying assets at a discount to the intrinsic value of the property. Time and reasonable care and effort will result in unlocking value, and you can profit handsomely simply by selling the property for what it is worth. You do not have to hope you find a foolish buyer willing to give you more than it is worth. That is not a strategy. Find unloved properties, ugly ducklings and hidden gems that you can buy on sale, take a little care, fix them up, and you can rent or sell for a fair price.
2.) Doing business with relatives. It is not a great idea in any context. But if you do business directly with the wrong relative in your Self-Directed IRA, it is actually illegal – and could result in severe fines, taxes and penalties.
Congress expressly forbids owners of Self-Directed IRAs from using them to buy from, borrow from, lend to or sell to certain family members. Specifically, you cannot transact with these individuals:
- Your spouse
- Your own descendants and those of your spouse
- Your own grandparents and great grandparents and those of your spouse
- Your attorney, accountant or advisor who advises you on your Self-Directed IRA in a fiduciary capacity
- Any entities controlled by any of these prohibited counterparties.
3.) Commingling funds. You cannot involve your own personal funds in your Self-Directed IRA investment in any way. All purchases related to your investment must come from your Self- Directed IRA account that contains the property. Technically, by law, you cannot even change a lightbulb in your property unless you bought the bulb with money from your Self-Directed IRA account.
Self-Directed IRA owners should work closely with American IRA, LLC to ensure that all transactions related to your property are routed through your IRA account.
4.) Accepting rent payments personally. If you are renting out a Real Estate IRA property, you cannot accept a rent check made out to your own name. Rents and all other payments related to your Self-Directed IRA must be made out to the entity that holds the property, or to your Self-Directed IRA account itself.
Likewise, you cannot take a cash payment directly. Doing so risks having the IRS declare the payment to be a prohibited transaction, potentially triggering the disallowance of the Self- Directed IRA’s tax advantages, along with tax liability, penalties and lots of legal bills.
5.) Signing a personal guarantee for a real estate IRA mortgage. The law mandates that you cannot pledge your Self-Directed IRA asset as collateral for a personal or business loan outside of the IRA. All mortgages on your Self-Directed IRA property must be on a non-recourse That means that in the event you default, the only course the lender can take is to foreclose on the property itself. They cannot come after you, personally. If you sign a personal guarantee, or pledge non-IRA assets to secure the loan, the IRS could strip your account of its tax- advantaged status, resulting in significant taxes and penalties.
6.) Forgetting about RMDs. Real estate is highly illiquid. But if you have assets in a Self-Directed IRA, Self-Directed Solo 401(K) or other tax-deferred savings vehicle, you will need to come up with cash each year to make your required minimum distribution, beginning by April 1st of the year following the year in which you turn age 70 1/2.
Self-Directed IRA owners should plan ahead so they are not caught in a cash crunch, unable to quickly raise the money within the IRA to make the RMD.
7.) Paying a high percentage each year just to hold the asset. Many Self-Directed IRA firms charge a percentage of assets under management to hold IRA properties on your behalf. Many times this is needlessly expensive and inefficient.
For investors who tend to buy and hold over long periods of time, switching to American IRA’s flat-rate, menu-based fee structure, rather than a high expense ratio, wrap fee or other AUM charge can save thousands of dollars each year on fees.
Interested in learning more about Self-Directed IRAs? Contact American IRA, LLC at 866-7500-IRA (472) for a free consultation. Or visit us online at www.AmericanIRA.com.