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 Going the Non-Traditional Route

One nice thing about IRAs — including SEP IRAs, SIMPLE IRAs, and Roth IRAs — is that you have some freedom to manage the investments in them as you see fit. So you’re not necessarily restricted to investing only in traditional retirement account assets such as publicly traded stocks, bonds, mutual funds, Treasuries, and money market instruments.

In fact, the Tax Code allows you to invest your IRA dollars in almost anything within

 If you are interested in alternative IRA assets, it's generally prudent to keep them segregated in designated accounts. Keep your other IRA balances devoted to traditional retirement account investments.

Avoid Unrelated Business
Taxable Income

    Certain types of IRA investments can potentially trigger unrelated business taxable income (UBTI). When this happens, your IRA may owe federal income tax, which really defeats the whole purpose of the account. The UBTI rules are intended to prevent IRAs from investing in income-producing businesses via direct ownership or via ownership of a partnership or LLC interest. An example might include using an IRA to buy an interest in a cattle breeding partnership.
As mentioned in this article, leveraged assets can also generate UBTI for an IRA. So investing in a partnership that owns leveraged assets could cause UBTI problems.
The good news: Rental income from real property is generally excluded from the definition of UBTI (assuming the property is not mortgaged). Therefore, using your IRA to buy unmortgaged rental real estate and collect the resulting net rental income should not trigger the UBTI rules.
Similarly, using your IRA to buy oil and gas royalty ownership interests won't trigger UBTI (assuming the interests are not leveraged).

limits, other than life insurance and collectibles. For this purpose, collectibles include works of art, rugs, antiques, metals, gems, jewelry, stamps, coins, alcoholic beverages, and certain other tangible personal property.

Since this involves the tax code, there are exceptions to the exceptions. For example, one exception to the “no collectibles rule” allows an IRA to buy certain gold and silver coins minted by the United States or by U.S. states. Another exception says your IRA can invest in high quality gold, silver, platinum, and palladium bullion. However, any such bullion must be kept in the physical possession of your IRA trustee.

Fair enough. Beyond what we've just described, however, you won’t find very many clear answers on the types of “alternative investments” that are permissible for your IRA and the types that are banned. With that thought in mind, here’s a quick summary of what you can and can’t do.

Watch Out for These No-Nos

There are "prohibited transaction rules" intended to prevent you from using IRA money to engage in certain "self-dealing" transactions, which are deemed to be inconsistent with an IRA’s status as a tax-favored retirement account.

Also, certain types of investments could cause your IRA to be taxed on so-called unrelated business taxable income (UBTI). That would have a negative effect because the advantage of tax deferral — or outright tax avoidance in the case of a Roth IRA — is the biggest selling point of individual retirement accounts. (See right-hand box for more information on UBTI.)

Because of the risks of running afoul of the prohibited transaction and UBTI rules and due to vague official guidance on permissible assets, many IRA trustees won’t allow these accounts to hold anything other than traditional retirement investments. That said, some companies specialize in functioning as IRA trustees for people who insist on alternative investments. If you are one of those people, please keep reading because suitable alternative investments, such as the following, can be held in what is often referred to as a "self-directed IRA:"

 Stock from an initial public offering.

 Closely held stock.

 Some real estate.

 Options to buy real estate.

 Oil and gas royalty interests.

 Stock options.

 Mortgages or loans to be held for investment.

This is not an exhaustive list. As you can see, some of these alternative investments are not liquid. This can present problems. If you have too much of your account tied up in illiquid investments, you won’t be able to dip into your IRA for cash when you need it. In particular, it is important to maintain enough liquidity to take your annual required minimum distributions after reaching age 70 1/2. Why? Because if you fail to take these minimum distributions, the IRS can penalize you for 50 percent of the difference between what you should have withdrawn from your account each year and what you actually withdrew (if anything). Thankfully, Roth IRAs are not subject to the required minimum distribution rules until after the account owner dies.

Real Estate as an IRA Investment

In general, you can use your IRA to invest in real estate. You may find this idea attractive — especially if you think the stock market is overvalued, real estate is a better deal, and you have been disheartened by the relatively low rates of return currently offered by most traditional fixed income investments.

Your IRA must own the real estate strictly as an investment, which means no use by you or certain family members. The IRA trustee must hold legal title to the property. Finally, your IRA must have sufficient liquid assets (either from other investments in the account or from your annual contributions) to cover any costs associated with owning and operating the real estate.

Remember: You lose some tax advantages by holding real estate in a traditional IRA, SEP IRA, or SIMPLE IRA. Specifically, you won’t benefit from the 15 percent maximum federal income tax rate on long-term real estate gains (25 percent for long-term gains attributable to depreciation), and you can’t claim current deductions for mortgage interest, property taxes, depreciation, and so forth which you can typically write off on your Form 1040. However, if you use a Roth IRA to invest in real estate, the property can be sold with the gain eventually distributed federal-income-tax-free (and maybe state-income-tax-free too) to you or your heirs, assuming the rules for tax-free Roth IRA distributions are met.

Unmortgaged rental properties are a potentially good choice for IRAs. Real estate mutual funds and REITs are also viable options.

Mortgaged real estate is less advisable, because leveraged property can potentially create UBTI and a resulting federal income tax bill for your IRA. Bottom line: your IRA must have enough liquidity to service the debt, pay for any other expenses related to the property, and pay any UBTI tax bills. If you still insist in investing in mortgaged property, the debt must be in the name of the IRA trustee and not in your name. Also, you cannot be secondarily liable for mortgages against property owned by your IRA.

Using an IRA to invest in a real estate partnership may also trigger UBTI problems.

Bottom Line: Consult with your tax adviser before using your IRA to invest in mortgaged real estate or a real estate partnership. You want to make sure the investment won’t create UBTI problems. For a large transaction, ask your tax adviser about getting a government ruling on this issue.

Avoid Prohibited Transactions

You must be careful that alternative IRA investments don’t run afoul of the prohibited transaction rules. If these rules are broken, your IRA’s tax-favored status may be lost. If that happens, your entire IRA balance would become taxable. To add insult to injury, you could also be hit with 10 percent penalty tax if you’re under age 59 1/2

In a nutshell, the prohibited transaction rules are primarily intended to prevent "self dealing" where the IRA owner uses the account’s money to meet personal financial objectives that are considered by the IRS to be inconsistent with the IRA's status as a tax-favored retirement account. Unfortunately, trying to interpret this area of the tax law is complicated. If you’re audited and the IRS discovers your IRA has engaged in a questionable transaction, the IRS and possibly the Department of Labor (which also has jurisdiction over IRAs) will examine the “facts and circumstances” to determine whether the transaction violated the rules. Examples of what the IRS (and the Department of Labor) may consider to be prohibited transactions include having your IRA:

 Buy stock or other assets from you or sell them to you.

 Lease assets from you or to you.

 Buy stock in a corporation in which you have a controlling interest.

 Lend to you or borrow from you.

 Engage in transactions with certain related parties or family members.

On the other hand, it should generally be okay to have your IRA:

 Invest in an initial public offering or closely held stock (assuming there’s no connection to you, certain related parties or family members).

 Invest in real estate (as discussed earlier).

 Invest in oil and gas royalty interests (assuming there’s no connection to you, certain related parties or family members).

 Buy publicly traded stock options and exchange traded funds (ETFs).

 Invest in options to buy real estate (assuming there’s no connection to you, certain related parties or family members).

 Issue mortgages or loans to be held for investment (assuming there’s no connection to you, certain related parties or family members).

Finding a Trustee to Handle Alternative Investments

As mentioned earlier, many of the best-known IRA trustees will not allow alternative investments for accounts under their supervision. So taxpayers may have to search for a trustee that will permit what they have in mind (for example, having an IRA invest in real estate and collect the rents). Suitable trustees are out there. In fact, functioning as a trustee for IRAs with alternative investments has become a bit of an industry in and of itself.

Of course, once potential trustees have been identified, taxpayers and their tax advisers should perform “due diligence” to make sure they are reputable and check their fee schedules. Having an IRA with alternative investments inevitably costs more than one with garden variety retirement plan investments. Hopefully, the alternative investments will perform well enough to cover the extra costs and then some.

As you can see, it’s true that IRAs (including SEP IRAs, SIMPLE IRAs, and Roth IRAs) can be used to hold a variety of nonstandard investments. However, this is a complex subject and there are many traps to avoid. Get your tax pro involved before committing to alternative investments with your retirement money. Ronald J. Cappuccio, J.D., LL.M.(Tax) 1800 Chapel Avenue West Suite 128 Cherry Hill, NJ 08002 Phone:(856) 665-2121      Fax: (856) 665-9005 Email:

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