Self-Directed IRAs Featured in Forbes' "365 Ways to Get Rich"

Most people don’t know that their retirement funds can be used to purchase “alternative” assets and still receive the tax benefits associated with their account.  We’ve learned as much in our ten years as administrators of self-directed IRAs (SDIRAs).

SDIRAs are popular because of their investment opportunities.

So, it was gratifying to see that SDIRAs were part of Forbes’ “365 Ways to Get Rich” article published this month. “Number 33” on the list encourages investors to put alternative assets in their IRA and the article even goes on to cite IRS code relating to SDIRAs. In this economic environment, where investors are exploring how to achieve real diversification for their portfolios, adjust to market conditions, or both, self directed IRAs are moving into mainstream consciousness.

Our role is growing as an administrator and custodian of IRAs, HSAs, 401(k)s, and Coverdell ESAs. It once seemed to be that all our energy needed to be devoted to educating account holders on the possibilities available to them. Now the focus is on the technology and client service needs of a rapidly increasing number of investors who want to utilize SDIRAs. 

Financial technology has exploded in the last several years, making transactions faster and account information more accessible and more up-to-date.  To some extent, SDIRA providers have lagged behind this curve, but New Direction IRA has taken the lead in rolling out innovative technology-based services so that our clients have the widest array of account capability as well as the most current account information available.

In addition, New Direction IRA has kept its longtime dedication to personal client service by providing each account with a client representative and making sure that clients have the phone and email contact information they need to get their questions answered promptly. 

As our industry comes out from behind a veil of misinformation and lack of publicity into the mainstream, it is incumbent upon us to deliver the service level that American investors have come to expect from their financial service providers.  There is a wave of interest and participation in the services that we provide at New Direction IRA—and that’s exciting!  Our existing account holders have been pioneers in IRA investing, and their success has drawn the attention of the financial world.  We meet their entrepreneurial spirit with ever improving service and technology to enable them to make the most of their tax advantaged accounts.

Top 5 alternative investments for Self-Directed IRAs

1) Real Estate IRA
Investing retirement money in real estate can take many forms – a rental apartment which pays your IRA monthly, a house which is held in an IRA until you decide to sell, even your dream home, which you can live in after you retire. This real estate can even be in a foreign country, which opens your options greatly.

2) Land
Raw land can be purchased and held until the time is right to sell or build, purchased and leased for farm land or oil or cell towers – the possibilities are limited by your imagination. As someone famous said, they’re not making any more.

3) Gold and other precious metals
Your IRA can purchase gold coins, gold bars, electronic shares of gold. Buy now, sell when the time is right, and you’ll never have to worry about or pay for storage.

4) Loan
Your IRA can provide loans for friends, businesses, or non-profit associations. If someone you know is paying 20% interest on a credit card, your IRA can loan them the money for 15%! As long as a person is not a direct lineal descendent (or yourself), your IRA can loan them money.

5)Private Stock
Find the next Microsoft, Apple or fill in your own successful business, and your IRA can buy some shares in them before they go public. Nanotechnology, biotechnology, or your next door neighbor’s fledgling cookie business, your IRA gets in before the world knows the true value of a start-up company.

Lending from your Self-Directed IRA

One of the more frequent inquiries we hear at New Direction regards the transacting of business between an IRA and a private company. For us to perform our jobs successfully for your IRA, we will often need a discussion with the account holder to discern whether the participation in the private company is a loan or a private stock (or equity) purchase. Both investments involve sending IRA money to the company with the expectation of a return, but the supporting documentation for the two types of investment are different.

A) “A loan”?

As you probably know, it is permissible for your IRA to loan money to a private individual, so long as that individual is not disqualified by virtue of IRS regulations. But an IRA can also lend moneys to a business – and this will also constitute the same sort of Private Lending. Companies will often need infusions of capital to “start-up” or fund their growth and development, and they may solicit potential capital infusions by offering attractive interest rates to Lenders (which could include an IRA).

The parties draw up a Promissory Note, spelling out the amount of funds to be loaned, and the terms of that Loan, and an inked signature of the Borrower on it — which the New Direction IRA client furnishes to us along with the Promissory Note Buy Direction Letter form.

The characteristic that most often indicates that the IRA’s asset is a loan (and not private stock) is that the return on the investment is agreed upon and fixed in the transaction documents. Remember, just as in the case of lending to an individual, lending to a company would only be prohibited if, for example, the IRA holder or other disqualified person is a majority owner or controlling officer of that company.

B) “Buying stock”?

Very often, smaller or growing companies elicit investment capital not only through acceptance of loans, but also by offering stock. In other words, though they’re still private, a company may sell stock shares to investors, giving those investors the opportunity to acquire equity in their enterprise. Since these companies are not publicly traded on stock exchanges, the only means to acquire a stock investment is through what is typically called a Purchase or Subscription Agreement, or Private Placement.

The company draws up their Agreement or Private Placement document, spelling out the number of shares to be purchased and price, which the IRA holder furnishes to us along with the Private Stock Buy Direction Letter and Disclaimer & Indemnity Agreement forms.

The characteristic that most often indicates that the IRA’s asset is private stock or private equity (and not a loan) is that the return on the investment is largely based on the performance of the company which is a variable.

C) “Convertible Notes”? (a kind of combo or hybrid)

It’s not uncommon for companies to also offer an investment opportunity which incorporates both the element of a Loan with that of Equity — by offering a Convertible Note. This is a kind of Loan, transacted as in the first example above, using a Promissory Note. The difference here is that the Note may provide an option at some point for the Lender to convert their creditor status for an actual ownership share (purchase of stock in the company), at some point in the future.

Once again, it is easy to see that there are a myriad of ways to exercise the freedom of your self directed IRA. However, because the supporting documentation for these types of investment are a little different, it is a good idea to decide the nature of the investment before beginning the acquisition process.

American Airlines offers employees Self-Directed IRA options

American Airlines declared bankruptcy in November 2012. More than 9,000 senior pilots are being asked to either roll their “B fund” retirement funds into an IRA or a company 401(k), or take a lump sum cash distribution. Many pilots are choosing to put their funds in a self-directed IRA, instead of taking a tax-burdened cash distribution or enrolling in the company 401(k) that offers few investments options.

The self-directed IRA is a viable choice for these pilots besides the fact that it is likely to incur the least amount of payments, fees and taxes out of the options presented by the airline. A self-directed IRA will allow pilots to choose their investments and diversify their accounts with assets in real estate, precious metals, private equity, publicly traded securities and more.

Most pension and retirement plans are written so that the employee doesn’t get many choices about where to invest his or her funds. This development for American Airlines provides a great opportunity for pilots to roll their funds over into a self-directed IRA account and investigate the thousands of investment options available.

With change comes opportunity—New Direction is available to help pilots take advantage of this opportunity.

New Direction IRA can help pilots navigate the investment of their IRAs. With more than 10 years of experience, an easy online portal for clients and a database of knowledge unparalleled in the self-directed IRA industry, New Direction provides a unique opportunity for pilots looking to invest their B-fund retirement accounts.

We handle the bookkeeping and administration of your account, you choose the investments.

Like all investments, due diligence is required to decide what will work best for your IRA and its investments. New Direction IRA can help with the administration and bookkeeping of your IRA, and will ensure your transactions and/or conversions are done according to IRS code.

Case study: How not to partner with your IRA to purchase assets

A recent Wall Street Journal article outlined the case of two Colorado men whose self-directed IRA investments were deemed unlawful by the IRS after they coupled a personal line of credit with an LLC they had created with their IRAs to buy a business. The men were assessed $45,000 in penalties and approximately $225,000 in taxes each.

According to a U.S. Tax Court decision on May 9^th cited in the WSJ piece:

“[The] two men each used $309,000 of assets from their respective IRAs in August 2001 to buy two 50% shares in a corporation. The corporation then paid $1.1 million to buy Abbot Fire & Safety, a provider of fire alarms, sprinkler systems and related equipment. The purchase price consisted of $400,000 of the taxpayers' IRA assets, a bank loan and other funds, including a $200,000 promissory note personally guaranteed by the two men. The note was secured by their homes.”

The tax court ruled that the personally guaranteed notes constituted a prohibited transaction. The notes guaranteed by the men were considered an “indirect extension of credit,” thus forcing a termination of the IRAs when the men bought the business. Therefore, the IRS sought to collect taxes on the distribution of those IRA funds.

Because a statute of limitations disallowed the IRS from collecting taxes when the business began in 2001, the court ruled it could only seek taxes from when the business dissolved in 2006. Those capital gains taxes amounted to $224,000 and $243,000 for the respective men.

Although this incident was unfortunate for the two men, many self-directed investors have made prohibited transactions similar to this whether they knew what they were doing or not. This case highlights the need for educating self-directed investors and finding an SDIRA provider that will be an ally throughout the investment process.

Self-directing retirement funds into alternative assets can be a powerful investment tool. When investors fail to abide by the laws, it is not an affirmation that SDIRAs are high risk or require endless amounts of paperwork to be legal. The investors in this case did not take the time to learn critical information about their IRA investment structure.

At New Direction, we have thousands of SDIRA investors that effortlessly abide by rules. As a leading provider of SDIRAs, we focus on educating investors and creating a comprehensive and complete paper trail of their transactions so that they won’t commit prohibited transactions or other illegal activities.

Think of it this way: the things in which you invest your retirement funds may be high risk; that’s your prerogative. But the self-directed IRA itself is not high risk if you’re with the right company.

Why did I get a 1099-R? I didn't make a distribution.

This discussion is relevant to those of you who receieved a 1099-R without making a distribution and/or anyone who rolled over funds from a 401k to an IRA. This post is designed to help you learn about how 1099-R and 5498 forms.

There are several reasons why people receive 1099-Rs. You will receive a 1099-R if you:

-          Take a distribution from a retirement account.

-          Make a conversion of a Traditional IRA to a Roth IRA.

-          Devalue an asset to zero.

-          Roll funds over from a 401k to an IRA or other retirement plan.

-          Roll funds over from an IRA to an HSA.

Depending on the reason you receive a 1099-R, you may or may not have tax consequences (see the discussion of the 5498 form below), but it is still good to understand the form and why you received it.

If you did one of the first two items on the above list, your reported income will increase by the amount on the 1099-R form. If your asset was devalued to zero, you essentially are paying tax on a distribution that has zero value. Tax on something worth nothing is also equal to nothing.

If you received the 1099-R form for one of the last 2 reasons listed above, another reporting form becomes relevant, form 5498 which is also filed with the IRS by New Direction IRA as part of our annual IRS reporting. The 5498 will reflect the results of any rollovers you made to accounts held by us.

For example, if you rolled funds from an IRA to an HSA, the 5498 will reflect that the amount reported on the 1099-R was rolled over into an HSA and not received by you personally (the IRS only allows that once in your lifetime). The same is true if you rolled funds over to an IRA from a 401k plan. The net result is that the 5498 will indicate that the amount reported on the 1099-R did not result in increased income for the current tax year.

Your first statement of the year serves as your substitute form 5498. You can reference this form for your records. As long as the amounts on the 1099-R match the amount listed as the rollover which funded your account on your statement from us, the net resulting tax is zero. Keep your statement (substitute 5498) and the 1099-R form with your tax files for documentation.