Investing With A Self-Directed IRA

Posted On: 2007-01-30Length:

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Hello, and welcome to Money Girl's quick and dirty tips for a richer life.

Today's topic: how to take control of your IRA. Today I'm going to be talking about something really cool-a self-directed IRA. Did you know that the IRS actually allows you to invest in just about any type of asset with your IRA? In fact, there are only three types of investments the IRS excludes from an IRA. Collectibles, for example, art, antiques, jewelry, or coins, other than US gold coins, life insurance, and S corporations. When I first found out it was possible to invest in things other than stocks, bonds and mutual funds with an IRA, I wondered why it was I hadn't heard about it earlier. I'd been contributing to an IRA for many years, yet I never knew I could make all types of investments with my IRA money, except for those three excluded things. I mean, gosh, if I could invest in real estate, or a privately held business, for example, with IRA funds, or better yet, Roth IRA funds, that would be pretty neat.

The reason that you rarely hear that it's possible, is that most IRA custodians are traditional banks or brokerages, and they offer stocks and mutual funds. After I heard it was possible to invest in other types of assets, just for kicks, I called up Fidelity, who happened to be my IRA custodian, and said, "I'd like to invest in real estate with my IRA money. What do I need to do?" Well, that retirement advisor sure was wondering what planet I was from. But he was very helpful nonetheless and pointed me to some real estate related mutual funds. He was unaware that it was possible to purchase real estate with an IRA, which is not at all surprising because it isn't possible with traditional banks and brokerages.

To invest in other types of assets, you need to open what's called a self-directed IRA with a custodian that allows you to invest in the full range of asset types allowed by the IRS. With a self-directed IRA, you can invest in real estate and privately held businesses, make secured loans, such as a mortgage, make unsecured loans, and also invest in traditional assets such as stocks and mutual funds. With real estate bought by a self-directed IRA, any income or capital gains grow tax-deferred, in the case of a traditional IRA, or tax-free in the case of a Roth. Pretty cool. In the last episode I talked about the concept of leverage. And it is possible to buy property with leverage in your IRA. There are some lenders who will lend on real estate purchased by an IRA. However, leveraging with an IRA can result in a special kind of tax on the income and capital gains from the leveraged portion of the investment. In most cases this tax is higher than what you would pay if you bought and financed a property personally, rather than through your IRA. But it's good to know that it is possible to use leverage when buying real estate with an IRA. For those of you who might be interested in diversifying your IRA investment beyond stocks, bonds and mutual funds, you might...