How to Invest With Your Self-Directed IRA

A Self-Directed IRA (SDIRA) is a tax-advantaged account that allows you to save for retirement. This type of account gives you more flexibility by expanding your IRA investment options to include certain alternative investments, like real estate or litigation financing. It also gives you more control over your investments by allowing you to manage them yourself. With a Self-Directed IRA, your investment options are not limited to stocks, bonds, mutual funds, and similar asset classes that you’re usually restricted to with traditional IRAs and Roth IRAs. 

While Self-Directed IRAs do offer these unique investment options, some industries are more favorable than others. With a plethora of investment options out there, finding the most suitable asset classes, industry exposures, and risk profile for you takes a little research. To get you started, we’ve outlined the primary benefits of a Self-Directed IRA and a sample of investment options available, that include investing in real estate, commercial finance, and litigation finance.

Potential benefits of investing with a Self-Directed IRA

Investing in alternative assets can be beneficial as it enables you to diversify your portfolio with assets from a variety of industries with typically low correlation to the stock market. Along with helping protect your portfolio against an economic downturn, alternative assets can also help protect your gains against inflation, as paper assets (such as bonds and equities) are most vulnerable to inflation. Making a direct investment into something that will produce income or provide an opportunity for a gain in value can remove middle-men and reduce fees.  

A Self-Directed IRA can be helpful in maximizing your tax-efficient investment strategy.  Investments that spin off interest and short-term capital gains are giving you taxable income that is taxed at your marginal tax rate, up to 37%. These investments are best held in your retirement accounts. Investments that give you returns in the form of long-term capital gains are taxed at, oftentimes, a lower rate of 0%, 15% or 20%. These advantages, in addition to the tax benefits that come with holding an IRA, make Self-Directed IRAs an appealing option for many investors, regardless of experience level. 

Self-Directed IRA investment options

Depending on your retirement goals, the following industries could be viable options for your Self-Directed IRA.

Real estate IRA investment options

One of the most popular IRA investment options, real estate, is a familiar asset for current property owners. It is already associated with building equity and has been seen as a stable investment for generations. That said, investing in property with a Self-Directed IRA is systematically different from investing in a home for personal use. The IRS has strict rules surrounding the investing process and purchasing real estate with your IRA incorrectly can be costly.

Rules for investing in real estate

• No self-dealing: You cannot buy or sell the property to or from a related party.
• No DIY improvements: Lifting a hammer or even a screwdriver to the property is prohibited. The IRS insists that all repairs and maintenance be done through an unrelated third party.
• No personal use: You cannot live in or on the property.

Real estate: what you can invest in

Now that we’ve covered the nitty-gritty of what you can’t do, we can get to the interesting topics: what you can invest in. The good news is you have options. You can invest your Self-Directed IRA in the following:

• Residential real estate: Single and multi-family homes, condos, and mobile homes
• Commercial real estate: Office buildings, salons, gas stations, shops, or other businesses
• Vacant land: Undeveloped lots
• Trust deeds: Agreements between borrowers and lenders that property will be held by a neutral third party serving as a trustee
• Mortgage notes: Documents signed at closing detailing the cost of the mortgage and its payment timeline

Real estate investment risks

While investing in real estate is a popular option, it does come with risks, so be sure to do your homework before jumping into a purchase. Thoroughly researching the geographic area you’re looking to buy in, for instance, can be crucial to getting the most out of your investment. When researching the market, remember to look into the demographics, income, and local economy of the area. 

Also, take note of the economic patterns commonly associated with that region. Urban areas, for example, tend to be more resilient to the effects of economic downturn and often recover more quickly. Being mindful of the impact of prior economic hits on your potential investment will help you make wiser investment decisions.

Funding real estate investments

When it comes time to fund your real estate investment, there are a few ways to go about it. You can make a direct purchase, combine personal funds with existing IRA funds or make a leveraged purchase. You could also invest in a real estate investment trust (REIT). Generally, these are entities that own and/or operate income-producing real estate in sectors such as retail and healthcare. 

Investing in real estate through a Self-Directed IRA opens up a world of opportunities, but it’s essential to navigate the rules and risks wisely. From residential properties to commercial spaces, the options are vast, and the potential rewards are enticing.

Keep in mind that deploying leverage with your IRA could make some of the gains and income taxable. The method you choose to fund your investment with is up to you, so be sure to do your due diligence and definitely consider speaking with a financial advisor before committing to one strategy or another.

Commercial finance IRA investment options

Another Self-Directed IRA investment option is commercial finance or businesses. You can make an equity investment in a business from your Self-Directed IRA by either purchasing an existing company or starting your own.  

Potential benefits of investing in commercial finance

If you’re already planning to start a business, using funds from your SDIRA to support its growth – while also serving as an alternative long-term retirement plan – can benefit your business now and your retirement plan down the line. Even if you aren’t one to start a business, you can invest a portion of your Self-Directed IRA funds into an existing business.

Risks of investing in commercial finance

Outside of the inherent risks of investing in a business, the IRS has strict rules about where you can invest, how much, and who benefits from it. Breaking these rules can be costly, so be sure to familiarize yourself with the following prior to investing in any business.

• Investing in an S corporation is prohibited. The tax definitions behind S corporations fall under “prohibited transactions.”
• Avoid disqualified parties. Your parents, children, and spouse are all considered “disqualified parties” and they are unable to invest in your business with a Self-Directed IRA or to benefit from your account. 
• Avoid self-dealing. As with other SDIRA investments, you cannot benefit directly from your investments before retirement. To avoid this, you must own less than 50 percent of the business and you must have a boss–you cannot be the primary employee.

(Please consult your CPA or other tax professional for guidance regarding your specific situation as Yieldstreet does not provide tax advice.)

Litigation finance IRA investment options

Litigation finance comes in many forms, including pre-settlement funding where an investor can advance funds to plaintiffs and defendants as their case plays out. If you’re considering investing in litigation finance, both law firms and their clients can benefit from this investment option by reducing litigation risk, managing budgets, and maintaining corporate balance sheets.

This kind of investment can also benefit you by helping to diversify your portfolio, as it typically has a low correlation to the stock market. So, if you have already invested in real estate, for instance, your litigation investments are unlikely to fluctuate in tandem with them. 

Litigation finance: what you can invest in

As we mentioned briefly, litigation finance opens the doors to a variety of Self-Directed IRA investment options. Here are some of the ways you can start saving for retirement by investing in litigation finance:

• Pre-settlement funding: Provide a “cash advance” to plaintiffs against the anticipated settlement of a personal injury suit on a non-recourse basis.
• Law firm financing: Help attorneys who offer contingency fee representation manage their cash flow during long-term cases. 
• Buyout of law firms: Make leveraged-buyout loans to law firms looking to acquire another firm.
• Legal advertising Help finance large advertising campaigns for law firms.
• Post-settlement financing: Providing up-front financial assistance to plaintiffs awaiting settlement funds.

Risks of investing in litigation finance

Though the payoff may be worth it, like all forms of investing, using your Self-Directed IRA to invest in this option isn’t entirely risk-free. Pre-settlement funding, for example, can be especially risky as plaintiffs can quickly run low on funds, leaving them unable to repay their legal fees with interest. To protect yourself and your investments, it is important to do your due diligence and consider working with a third party before investing in any aspect of litigation.

Steps to investing with your Self-Directed IRA

The steps for investing in each of these alternative IRA investment options differ slightly from industry to industry. That said, there are preliminary steps that apply to each option regardless of asset class.

1. Decide on the asset class you want to invest in

It is wise to be well-versed in both the asset class and the industry you invest in, so give yourself time to do ample research. At the same time, remember to keep your current investments in mind to determine how your SDIRA will support your existing portfolio. You may also want to consider who will manage your investment at this time. If so, be sure to look out for third parties who specialize in alternative assets. 

 2. Determine how you want to fund your IRA

Before opening your Self-Directed IRA, it’s important to know where you’ll pull your investment funds from. If you already hold an IRA, you may choose to transfer or rollover funds from an existing account. The IRS has strict rules around timing and frequency of rollovers, so be sure to understand these regulations fully before making any moves. 

If you don’t already hold an IRA, you may choose to form an LLC to protect your assets.

3. Locate and hire a custodian

Your custodian is a neutral third party who holds your investments and helps ensure that you meet government and IRS regulations. They cannot provide financial advice or manage your investments, but you should still take the time to identify and hire a reputable custodian. When shopping around, consider their experience, portfolios, reputational information (for example, see the Better Business Bureau), and ensure their fees are competitive.

4. Open your Self-Directed IRA 

Once you find a custodian you trust, you can work with them to transfer funds from your other retirement accounts and start investing. You may also want to hire a financial advisor at this time to help ensure you’re making the best decisions for your retirement goals. 

What to consider when weighing your IRA investment options

Investment risks by industry

Many of these alternative investments are illiquid, making them challenging to turn into cash if needed. For this reason, it’s beneficial to be well-versed in the industry you plan to invest in prior to investing any funds. Even experienced investors can have trouble navigating a new asset class, so consider working with a third party who has expertise in your potential investment area.

Prohibited transactions

In general, prohibited transactions involve “disqualified persons,” the account holder, or your beneficiary improperly using funds from your Self-Directed IRA. These disqualified persons include spouses, lineal ascendants, and lineal descendants, meaning family members including your parents or children and their spouses. The IRS places limitations on the way these individuals can interact with and benefit from your Self-Directed IRA. Some prohibited transactions include using your SDIRA to secure a loan or to purchase a home for personal use.

Prohibited investments

Breaking IRS rules around your IRA investment options eliminates the tax benefits of your retirement fund and can lead to additional fees and/or penalties. The details surrounding prohibited investments vary between different industries and specific assets. To give you an idea of what the IRS prohibits, the following are examples of prohibited investments:

• Antiques: Artwork, antiques, and collectables cannot be held by IRA accounts. This includes baseball cards, stamps, furniture, and jewelry. You can lend money to people who buy these things though or invest in a company that is in the business of collectibles.  
• Coins: Most gold coins are prohibited from IRA accounts. The few permitted coins have a high mineral content and are not seen as collector coins.
• Life Insurance: In general, you cannot use the funds in your SDIRA to purchase a life insurance policy. 

With so many IRA investment options available, taking the benefits and risks of each one into account is crucial to get the most out of your retirement plan. Use this guide to narrow in on the best opportunity for your retirement goals and start exploring your options.

Interested in investing with a Self-Directed IRA? We can help. The Yieldstreet platform allows accredited investors to help diversify their retirement portfolio by investing in alternative assets with their SDIRA. Don’t have a Self-Directed IRA set up? We can help with that too. 

Still have additional questions or want to learn more about your investment opportunities? Reach out to us at [email protected].

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