Self-Directed IRA: Is it Even Legal?

The self-directed IRA has given rise to many questions. People often ask me whether it is actually even a legal strategy. The fact is that you have been able to buy other assets (including real estate) within your IRA account since the early days when IRAs were created. In reality is that the IRS generally only prohibits investments in artwork, stamps, rugs, antiques, gems and insurance contracts. So other assets are fair game. All you have to do is establish a “self-directed” IRA with a custodian.

A self-directed IRA is legally not any different from any other IRA account. The term "self-directed" simply means that you can choose the investments in the IRA. I think that often a misconception exists because most IRA trustees do not even allow real estate (or non-traditional investments) in their IRAs. This is due to the fact that they have their own portfolio of investments to market as well as concerns over higher administrative costs associated with the self-directed IRA market. But with the recent real estate activity, investors are looking for creative ways to invest (and trustees are looking for extra ways to make some cash).

Now that you know that you can do it, the discussion turns to “should” you do it? Well the answer here may not be the same for every person. Each investor needs to determine his or her risk tolerance and decide on a proper asset allocation. The consultation with an attorney, CPA and financial planner is a must as you should make sure that all parties are on the same page.

Be aware that self-directed IRAs often have greater administrative costs, but they can allow you to take greater control of your investments. If you are tired of losing money in traditional IRA investments (stocks, bonds, mutual funds, etc) this is definitely a great avenue for you to explore.

It clearly depends on how much of your net worth is tied up in real estate. I have read articles saying that everyone should have 20% to 30% of their investments in real estate. Now I’m not going to prescribe a specific percentage. Each person has their own comfort zone. But certainly everyone should have some form of real estate investment, even if it is a real estate investment trust (“REIT”).

Not only is real estate a great investment, but it is less volatile than stocks and is also negatively correlated to stock market returns. But because real estate is generally actively managed, many folks may not have the stomach for it. So determining whether you should hold real estate in your IRA depends, in part, on your overall portfolio mix and your temperament.

However, the tax deferred nature of IRAs should not be ignored. An IRA may be a great vehicle for your real estate investments if you have a real estate strategy that would otherwise result in short-term capital gains.

Answering questions about retirement investments is never easy. Please make sure you do your own research and clearly understand any changes to your retirement assets. But for people who desire the ultimate control and flexibility that a self-directed IRA offers, it can be a wise choice. Putting real estate in an IRA may be an even better one.