How to Set Up a Self-Directed IRA

Self-directed IRAs allow you to invest in real estate.

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The Securities and Exchange Commission defines a self-directed IRA as “an IRA held by a trustee or custodian that permits investment in a broader set of assets than is permitted by most IRA custodians.” Self-directed IRAs allow individuals and small companies to invest in asset classes that are often deemed illiquid. These include tax lien certificates, real estate, and private companies. Hence, self-directed IRAs allow people who prefer to leverage their personal expertise in their investments to do so. The choices of investments are simply expanded in these types of IRAs.

Setting Up a Self-Directed IRA

Confirm that a self-directed IRA can invest in your preferred asset class. Although a self-directed IRA allows you to invest in numerous illiquid assets, investments in some assets are prohibited. Collectibles, including artwork, stamps and rugs, are a prohibited asset class. In addition, you cannot use an IRA to invest in real estate that you will personally use.

Choose the financial institution that is right for you.

Select your financial institution. Banks, insurance companies, mutual companies and brokerage firms comprise the majority of IRA custodians and trustees. These firms generally invest only in the marketable securities they offer or sell. These include stocks, bonds, CDs, annuities, and mutual funds. You probably will need to do some research to find an approved institution that allows you to invest in the assets you prefer.

Then, complete the application in its entirety. As with other IRA accounts, you will need to provide your Social Security number and an approved form of photo identification. You must complete and sign the IRA agreements and disclosures.

Remember to pay any application fees. The asset classes self-directed IRAs allow often require individualized attention to ensure compliance with IRS rules and regulations. Therefore, self-directed IRAs generally incur higher administrative costs because of this increased level of administrative oversight and paperwork required. Financial institutions typically pass on these costs to the IRA account holder.

Once the IRA is set up, you must fund your self-directed IRA account. You can make a one-time contribution or set up an automatic investment plan. You can transfer money directly from another IRA or an employer's qualified pension plan. Alternatively, you can roll over the money by taking temporary possession of it yourself. In the latter case, make sure you deposit the money within the 60-day time frame required by federal rules or else you will incur a penalty and taxes.

Self-directed IRAs allow investments in alternative assets that do not come with the level of information available as do publicly traded securities. Make sure you have a comfortable understanding of any asset you choose to invest in. Do your homework before making an investment and continually monitor any investments you make.

Because the trustee or custodian is not providing firm-approved marketable securities for you to purchase, the burden of ensuring an asset is a viable investment rests solely with you. Be aware that the SEC has warned of fraud with self-directed IRAs.

Setting Up an IRA LLC

In some cases, you may set up a limited liability company that is owned by your self-directed IRA to own assets on your behalf. Talk to a lawyer or financial advisor about the legal benefits and costs involved in doing so.

2018 Tax Law Changes

The 2018 tax law changes won't affect the rules around IRAs, but the lower tax brackets may affect what investments make sense to make inside or outside of your IRA.

2017 Tax Law

Tax rates were higher for most taxpayers in 2017 than they will be in subsequent years, which may affect how you manage your investments and assets.