Getting Started with a Self-Directed IRA

To begin investing in real estate, small business, crypto, precious metals, & other alternative assets with a self-directed IRA: https://directedira.com/appointment/

In this episode, I break down self-directed IRAs and how investors can use retirement funds to build wealth beyond traditional stocks and mutual funds. You’ll learn the basics of SDIRAs, the types of alternative assets you can invest in, key IRS rules to avoid costly mistakes, and strategies for using retirement accounts to invest in real estate, private deals, and more. Whether you’re new to self-directed investing or looking to expand your retirement strategy, this episode gives you everything to get started.

For questions or to learn more about this episode's topic, book a call with an IRA specialist here: https://directedira.com/appointment/

Other:

Mat Sorensen: https://matsorensen.com

Mark J. Kohler: https://markjkohler.com/ 

KKOS: https://kkoslawyers.com

Main Street Business https://mainstreetbusiness.com

Transcript

Your IRA Is Not Stock Only

SPEAKER_01 0:06

Most people think that their IRA is stuck in the stock market. Stocks, ETFs, target date funds, mutual funds, that's it. But that's actually not true. Your IRA can own real estate. It can own a private fund, a private company, it can make private loans. It can even own crypto. And here's the part most people miss. The rules have allowed you to do this for decades. You've always been able to do this with an IRA since IRAs first came into existence. The limitation isn't necessarily the IRS or the tax code. The limitation is the company where your IRA account is at. If your IRA is at a brokerage firm, they usually only let you buy what they sell. But with a self-directed IRA, you can take the same retirement account and invest it into assets I actually understand and believe in. Now this is powerful, but it's not a free-for-all. There are some rules, there are primitive transactions, and there are people your IRA cannot do deals with. And if you get these rules wrong, you can lose all of the tax benefits of that account. I'm Matt Sorensen, attorney and CEO of Directed IRA. And in this video, I'm going to give you the complete beginner's guide to self-directed investing. We'll cover what that is, what you can invest in, how to set it up, the key rules, and the mistakes you're going to want to avoid. Because once you understand how self-directing works, your retirement account becomes more than a stock market account. It becomes a true wealth-building tool. Let's break

What A Self-Directed IRA Means

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it down. So what is a self-directed IRA? A self-directed IRA is not some special type of IRA. It's still an IRA. It can be a traditional IRA, a Roth IRA, a SEP IRA. It can even be a solo 401, a health savings account, or a Coverdell. The difference is the custodian of the account and what the custodian lets you do. Most people have a brokerage IRA with the broker dealer. And with the brokerage IRA, you can buy brokerage products like stocks, bonds, mutual funds, and ETFs. Why? Because that's what they sell. And if your IRA is in an insurance company like New York Life or Northwestern Mutual, what can your IRA buy? Annuities. Why? Because that's what they sell. A self-directed IRA custodian, however, lets your account invest into any asset allowed by law. These are sometimes called alternative assets, things like real estate. And I'm talking about like the duplex down the street, the single family rental. It could be a private fund, a private company, a small business, a private loan, precious metals, crypto, tax liens, notes. These are all things your IRA can own. So when someone says my IRA can't buy real estate, what they usually mean is my IRA that's at a brokerage firm can't buy real estate. It's not because the IRA rules don't allow you to buy real estate with your IRA, it's because the custodian you're at doesn't let you buy real estate with your IRA. And once you understand that, next question is quite simple. What can the account actually invest in? The general rule is this an IRA can invest in anything except a few prohibited assets. Now the prohibited assets are three. That's it. Life insurance contracts, collectibles. This would include like art, collectible cars, wine collections that turned into bottle collections, and also S corporation stock. Now, as a tax lawyer, I generally love S corporations for business owners, people selling goods or services, but your IRA just doesn't qualify as an S corporation shareholder. But an IRA could own an LLC, a C corporation, a limited partnership. All those assets are totally allowed. Just S corporations are the one entity an IRA can't own. But outside of those three things, your IRA can own anything that's an investment. Your IRA can buy real estate, the single family, the duplex, the commercial property, raw land, mobile home parks, real estate notes, real estate funds. It can invest in private deals. This could be startups, private companies, the small business in your community, an LLC, a limited partnership. This is why self-directed accounts are so popular with investors who already understand this asset class, who might be entrepreneurial. They might be a real estate investor. And if you know real estate, you may want to invest your retirement account into real estate. If you understand and like private lending, you may want your IRA to make loans and do private lending. If you know private equity, your technology, you may want to access those deals. Most people think retirement money has to stay with Wall Street. That's a misconception. Wall Street wants you to think. But in fact, your retirement account and the capital you already have sitting there can be invested in any asset allowed by law. The question is, whether it's trapped in a brokerage menu where you will be restricted, whether you can put it to work and assets you actually want to own and invest in with a self-directed

Why Tax Benefits Drive The Strategy

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IRA. Why are investors even using self-directed accounts though? Well, investors are using these accounts for one reason. They want the retirement account tax benefits on investments outside the stock market. Now, a lot of people are familiar with like buying stock in an IRA or 401k. And when you make money on that, you don't actually pay tax. So if I bought $100,000 of Apple stock that went up to $150,000 and I sell for $150,000, that whole $150 goes back into my retirement account. No capital gains, no tax, and now I'm reinvesting that $150,000, growing and compounding that over time. That's one of the great things about retirement accounts. Those rules don't just work for stock. I can do the same thing with the private company stock. I can do the same thing with real estate. If I bought real estate for 100 grand and sold it for 150, that whole 150 goes back in the account, no taxes, it's going to grow and compound. So the question becomes what assets do I think will grow and build the fastest? What do I know and what do I believe in? Because the retirement account, whether it's a publicly traded stock or mutual fund, or a private asset like real estate or a private company or private fund, it's the same beneficial tax treatment. Now remember, if you're using a traditional IRA, just like with stocks or mutual funds, you're growing and building that and it's taxed on the way out. You got tax deductions when you put the money in, no taxes you're growing, but you're paying taxes on the way out. And in a Roth IRA, or in our case here, a self-directed Roth IRA, remember when you're growing and building this, there's no taxes on the income and the gains, and everything gets to compound, plus it comes out tax-free at retirement. Now, this works, whether it's publicly traded stocks or privately traded assets like real estate or private companies or private funds. No tax on the way out. So let's say you want to invest in something off of Wall Street. You're tired of just buying stocks, bonds, and mutual funds.

Open And Fund The Account Correctly

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How do I actually set up a self-directed IRA? Well, it's actually quite simple. Step one, you're gonna open an account with an IRA custodian that allows for alternative assets, like our company, the best out there, directed IRA. Step two, we're going to fund the account. Now, most people are gonna fund the account by transferring money from an existing brokerage IRA. You've got 200 grand at Fidelity that you don't want to invest in stocks, bonds, or mutual funds anymore. You can transfer that. If it's a traditional IRA at Fidelity, you'll open up a traditional IRA, your self-directed IRA custodian. And that's gonna be no tax, no penalty. You're just moving from one IRA custodian to another. The difference is the new IRA custodian is a self-directed one that allows you to invest in alternative assets. Now you could also roll over an old employer 401k to the self-directed IRA, or you could just be making new contributions to the new IRA account of $7,500 a year. When you're funding your new self-directed account, though, there are some mistakes that people make. The first mistake is they go and find the deal before they've even opened up the self-directed account or have any money in it. Then they realize deal documents need to be signed tomorrow. They might need to send earnest money on a real estate deal or send money within five or 10 days. And they haven't even opened up the account, got it funded, don't know how to do the documents or investing, and they're behind the eight ball. That is the wrong order. You need to get the account set up before you're actually going to make the investment or sign documents. You don't need to move your entire IRA over. So, for example, if you have $400,000 in a brokerage IRA and you want to invest $75,000 into a private real estate fund, you can transfer just the $75,000 to the self-directed IRA and leave the rest over at the brokerage IRA doing what you already had planned to do. You can have more than one IRA, you can have a brokerage IRA, and you can have a self-directed IRA. That's actually common and popular. But here's the key the investment into the private asset must be made from the self-directed IRA. The documents must be in the IRA's name. The money must come from the self-directed IRA, and then the income is gonna go back into that self-directed IRA. This is not your personal investment. Your name is not going on the documents. If this was an investment document, I'm not gonna put Matt Sorensen as the investor, purchaser, or subscriber, or buyer. I'm gonna put directed trust company, FBO Matt Sorensen's Roth IRA. That's who's making the investment. So you must actually have the account created and ready to go to get the documents rolling. Remember, this is not your personal investment. This is your IRA's investment. That distinction is everything when you're self-directing.

Keep Money And Paperwork In IRA

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So let's just say that your self-directed IRA was buying a rental property. Well, the IRA is gonna pay for the rental property. The IRA is gonna get the rental income from the property. The IRA is gonna pay the expenses on the property. If there's repairs, who pays for that? The IRA. When you sell the property and you make a gain, where does that income go? It goes back into your IRA. You don't take the rent personally, you don't pay the expenses personally, and you don't deposit the income into your personal checking account. You control the investment decisions, but remember, this is not you investing, this is your IRA investing. IRA owns the asset, your IRA gets the income, it gets all the compounding and tax beneficial rules, and making sure that you've distinguished what the IRA owns and what it's paying for and getting, the IRA's asset, versus you personally is critical.

Prohibited Transactions And Disqualified People

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And this leads us to the prohibited transaction rules, which are the most important rule you need to understand when you're self-directing your IRA. And these prohibited transaction rules are created to prevent you from using your IRA to benefit yourself personally today. Your IRA is supposed to benefit you in retirement, not personally today. So, for example, all of these clients say, Hey Matt, I own these options in this company I work for, or I own this real estate that's gone up in value, or this crypto. I don't want to sell it and pay taxes. Can my Roth IRA buy it from me personally? And then I'll sell it from my self-directed Roth IRA and pay zero tax? No, you cannot do that because of this prohibited transaction rule. Your IRA could buy new crypto, new real estate, new private company stock. It just can't buy it from you because the IRS doesn't trust you. Because they know what you would do is sell it for low value from yourself to your Roth IRA and then sell it from your Roth IRA and take all the gain entirely tax free. And if you can't do that, I would have a video about that and that strategy. It would be awesome, but the IRS restricted this. So when we're buying assets with a self-directed IRA, we're buying new assets. Now, who does the IRS restrict? The IRS under the prohibited transaction rules restricts your IRA from transacting with certain people. Now, this includes yourself, which we've already talked about, but also it includes your spouse. For any of you in Utah, this is all of your spouses. It includes your parents, your grandparents, your children, your grandchildren, spouses of your grandchildren. Okay, it includes your lineal family line. Your IRA cannot transact with them. It can't buy an asset from them. It can't sell an asset to them. It can't loan them money. It can't buy property for your personal use or rent property to your kids, and it can't invest in your own business. Remember, we're investing with a self-directed IRA. We're buying assets for investment purposes. We're trying to get as much income and gain and growth in that account as possible by investing it in an asset we know and believe in. Not an asset we're trying to get personal use of for us, our spouse, our kids, our parents. We're trying to grow and build a retirement account so we have a retirement we're actually looking forward to. So we've already talked about some private assets like real estate or crypto or private company stock that you can't buy with your IRA from yourself. But also, you can't buy an IRA, let's say like a vacation rental or an Airbnb property where you rent it out all year and then you want to stay in there one week out of the year because no one was using it. And I've had that call many times. Matt, can I stay at the Airbnb that my IRA owns? No, why not? I'm not gonna pay rent to my IRA, Matt. I'm not gonna transact with the IRA. I'm just gonna use it and no one else was gonna use it. Well, that causes another type of primitive transaction called a self-dealing primitive transaction, because now you're using and having benefit of the property without having to pay for it. That still causes a prohibited transaction. Well, man, what if I pay for it then? Then I won't have a self-dealing primitive transaction. Well, now you have a regular primitive transaction because you paid rent to your own IRA. So, bottom line, when your IRA owns an asset that can be used, and real estate's the most common in this example, you cannot have personal use of it, nor can anyone else who is a disqualified person. It's important to know though that the disqualified person list there includes you, your spouse, your kids, your parents, but it does not include your brothers and sisters, your cousins, your aunts or uncles, your friends. Those are people your IRA can actually transact with. Those people can use the assets in your IRA. Make them pay for it, though. We want to grow and build our IRA, of course. So knowing who is on this list and is a disqualified person is critical to knowing whether you need to worry about a prohibited transaction. I always say that self-directing an IRA is not rocket science. It's kind of more like a board game. So once you understand these rules, kind of like the board game that you play once or twice, it's the same rules over and over. But I want to go over some common mistakes and moves people make that are wrong. Number one, we've already talked about this, committing to a deal before you even have a self-directed IRA account. Remember, let's get the account open and funded before you go out to make an investment. Mistake number two, putting documents in your personal name. You're not buying that investment asset, your IRA is. If your IRA is investing, your IRA should be listed as the investor, buyer, purchaser, subscriber, whatever the documents are calling it. And remember, you would invest the asset in the name of the IRA. At an IRA at our company, best self-directed IRA company out there, directed IRA, it would say directed trust company, FBO, which means foreign on behalf of Matthew Sorensen, Roth IRA. Putting it in the name of the IRA. And of course, you would not put my name there, you would insert yours. Mistake number three, paying expenses personally. Remember, once your IRA owns the asset, your IRA is entitled to the income, but it also is responsible for the expenses on the asset. So make sure the IRA is paying the expenses on the asset, not you personally. Now there are some caveats to that. Administrative, accounting, legal fees for the IRA can be paid personally, but expenses for the asset itself should be paid for by the IRA. Mistake number four, taking income personally. If the IRA owns the asset, the IRA is entitled and must receive the income from the asset. Mistake number five, doing deals with disqualified persons and engaging in a prohibited transaction. This is where some people get excited and they'll say, like, well, my IRA is going to buy this property from my dad. My IRA will loan me to buy money for this business. My IRA will buy something from me, stock, private company, crypto that I actually already own. Be careful. Those are all prohibited transactions and all of those deals will blow up your entire IRA. Because if you have that prohibited transaction, your IRA becomes entirely disqualified. Stake number six, thinking the IRA custodian approves the investment. When you're using a self-directed IRA custodian, they're the custodian of the account and they process the transactions you request. They don't have investment options, they don't tell you what to invest into, and they don't review or approve any investments. They're not telling whether your investment is good or bad. So you've got to do your own diligence. Self-directed account means you, the owner of the account, are making the decisions and are self-directing the account into the investments that you choose that you understand to be the best investment. So you're taking responsibility for the investment. That's not a bad thing. That's in fact the whole point of a self-directed IRA is you get to take control of your retirement. You get to bear the fruits of your good investment decisions, but you're also responsible for the bad

Real Estate Example And Common Use Cases

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ones too. At this point, I think it's important to talk a little bit more about real estate held inside of a self-directed IRA. Real estate is one of the most common self-directed IRA investments. And investors like it because so many people understand the concept of rental income, cash flow on the property, appreciation, and they have an ability to assess a local market and probably find deals better than they could on the stock market. Let's just give a quick example here. And I'll just give you the rental property I bought with my own self-directed retirement account back in 2017. Well, I bought this cute little three-bedroom, one and a half bath single-family rental in Indianapolis for $84,000, money from my retirement account. Now, the income came in of rental income of $900 a month when I first rented it. By the time I sold it, five years later, I was actually getting $1,200 a month in rental income. Now, of course, I had expenses on the property and a property manager, but the majority of that rental income was going to my account as cash flow and building up in my account. Later in five years, I actually sold the property for $185,000, a $100,000 gain. And that gain went all back into my self-directed retirement account, zero tax. So my retirement account fucked the property. It was paying the expenses, paying for the property management, paying for the repairs, getting all of the cash flow, getting the appreciation, and then it received the entire gain on the sale, no tax, no need to reinvest in a short time period with like a 1031 exchange. And I was then able to deploy it, of course, into the next asset to let the account continue to compound and grow. And when real estate is done correctly inside of a retirement account, it's a powerful long-term wealth strategy. Now remember, you might be someone that loves real estate. And a lot of times I'll get people who ask me, Matt, so should I not buy real estate personally? No, that's not what I'm saying. I'm saying if you believe in real estate, have deals and opportunity in real estate, and think the future of the real estate is going to be great, why would you not be investing your IRA or retirement account in real estate? I'm not saying don't buy it personally. In fact, I own a lot of real estate personally. I also own it in my retirement account. My retirement account is my long-term wealth building strategy. Thinking of your IRA, 401k, Roth IRA, whatever tax advantage account it is, you should simply be thinking of what asset can I put in there that's gonna have the greatest returns and greatest appreciation so that that account will be as large as possible when I hit 59 and a half. That's all you need to be thinking about. Don't be thinking about should I buy it personally or should I buy it in my retirement account? What asset do I put here or there? Just focus on your retirement account and for a second, just think, what's the best asset I can put in it? Maybe it is a stock ETF or mutual fund. If so, do that. Maybe you want to make multiple bets or investments and put some in the stock market, some in real estate, some in crypto, some private companies, some in precious metals. I don't know. Invest in what you believe in and let's get the asset you believe in most and think has the greatest potential in your retirement account. And shocker, that might not be a stock bond or mutual fund. It actually might be something crazy like

Private Funds Lending And Due Diligence

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real estate. After real estate, the next most popular area of investing a self-directed IRA is going to be into private funds, private companies, and notes. Now, self-directed IRAs that are investing in these private assets could be real estate syndications, it could be a private equity fund, a venture fund, a startup, private credit or debt fund, or even a small business. Now the process is actually quite simple. Review the deal, you decide whether you want the IRA to invest, but the subscription documents, the investment documents, stock purchase agreement, whatever it is, that must be in the IRA's name. Remember, of course, the IRA is going to send the funds. You will approve that with your self-directed IRA custodian by doing what's called a by direction or direction of investment request, saying, hey, invest this into ABC private company or XYZ private fund. Then your IRA invest owns the asset and is entitled to any distributions of income or the sell of the private funders' shares whenever that may occur. Now the same thing applies to private lending, except when your IRA is lending money, remember on all the documents, the note or the mortgage or deed of trust securing the loan, those are going to be in the name of the IRA as the lender. You're not lending the money, your IRA is. IRA gets the interest, it gets the points, and it gets the principal when the loan is paid off. So for example, if your IRA loans $100,000 to another real estate investor, you put a lien on that property, you might charge them 10% interest and two points. That means they're going to pay you $2,000 in points, and you're going to get 10% interest if that money is loaned out for the year, which would be $10,000. And the interest is going back into the IRA and it's compounding and growing. And if this is a Roth IRA, coming out entirely tax free at retirement. But access to these private Investments do not eliminate risk. Borrowers can default. Private funds can underperform. Startups can fail. Real estate deals can go sideways. So you need to ask: who is the sponsor of this? Who is the person I'm speaking with? Who is the borrower? What's their track record? What are the fees involved? How long is my money locked up? What are the risks? Is there debt on this that could create something called UBIT? You need to be aware of these questions and make sure you have a good answer. The custodian is not doing diligence for this. You are. Self-directed investing gives you access, but access without diligence is dangerous. So make sure you're getting that done or engaging the professionals on your side to ensure you're making good private self-directed investments.

Who Self-Directing Fits And Framework

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Now, having said all of that, who are self-directed IRAs for? Well, self-directed IRAs are not for everyone. If you're happy in index funds and stocks and you're good at it and you like it, keep doing that. Self-directed investing may make sense if you understand alternative assets. Maybe that's real estate, maybe that's crypto, maybe that's private companies. I don't know what your expertise is, what you believe in, what you have access to, but whatever that might be, this is someone who is a great self-directed investor and who's going to have opportunities and ability to find deals. Maybe you're just someone that also wants to diversify outside of the stock market. All of your wealth is invested in the stock market, and you want to do something a little bit different. Also, you need to be someone who's comfortable with due diligence, comfortable looking at deals and saying no. And you might also be someone that has great investment opportunities, but you want to just be very strategic about it and use a self-directed Roth IRA so that all the investment returns and gains are entirely tax-free. These sound like the things that fit down your avatar, you're someone who would be a great self-directed investor. Now, this is not a good fit for someone who doesn't like the responsibility of making investment decisions, don't like illiquidity, or you're gonna need the money in a month or even a year. You don't want to evaluate deals. That sounds boring to you or sounds like a chore or a task. Or maybe you're someone that just likes an annuity or some safety or an advisor that puts you in very standard investments. The power of self-directing is that it lets you invest in the best asset you can find, period. It's not just about the best investment on the stock market, the best investment TD Ameritrade will let you invest into. It's the best investment you can find, period. When you're using a self-directed IRA and the $19 trillion in retirement accounts, just in IRAs, how do I use that money to invest in the best investment I can find that's gonna have the greatest return to give me the biggest retirement when I hit 59 and a half? That's what we're trying to do with a self-directed IRA. If you're getting started, here is a simple framework. Step one, decide what asset class you actually understand and want to invest into. Step two, decide which account should own this investment. Should this be a traditional IRA, a Roth IRA, a solo 401k, a health savings account? And think about the accounts you already have. Most people coming to a self-directed IRA are simply moving existing retirement account funds from a broker dealer IRA to their new self-directed IRA. Step three, open the self-directed retirement account with the custodian, lets you invest in private assets. Step four, fund the account before the money is due on your deal. This is usually coming from a transfer. It could be a rollover, could be a new contribution. Make sure those wheels are in motion and you understand the time deadlines and constraints of where the money's coming from. We can always move quickly on our end as a self-directed custodian at my company directed IRA, but the timeline is usually dictated on where the money's coming from, not us simply receiving it. So make sure you've got those timelines down. Step five, put the investment documents in the name of the IRA. At this point, you already have the IRA account set up, so we can put the investment documents in the name of the IRA. Again, the way we do it and most self-directed custodians is name of the IRA company, FBO, your name, and the account type. For example, for me, it's directed trust company, FBO, Matthew Sorensen's Roth IRA. Step six, keep the income and expenses inside the IRA. Separate yourself personally from this. You're not investing in this deal. You're not entitled to income. You're not responsible for the expenses. Your IRA is. And step seven, do not get involved with disqualified people. You, your spouse, your parents, your kids. Your IRA is not transacting with them. It's not buying or selling assets with them. It's not renting the property your IRA owns, and you're not using those assets personally because that would cause a prohibited transaction. Step eight, do your due diligence on the investment. Remember, you have the ability to invest in virtually any asset out there. You just can't buy collectibles, life insurance, and S corporation stock. Everything else is fair game. Just because you can invest in everything doesn't mean you should. Make sure you're finding the right assets that make sense for you. Now that's the roadmap. It is not magic. It's simply a process. Now, the best self-directed investors are not chasing every shiny object. They're not chasing investments that promise a 100% or ridiculous returns. Most of those don't work out. What they're doing is they know the rules, they pick the assets they understand and believe in, and they use the right account. So

Recap Next Steps And Disclaimers

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let's recap. A self-directed IRA is still an IRA. The difference is you're using a custodian that allows your retirement account to invest beyond the normal brokerage menu. Your IRA can own real estate, private funds, private companies, it can do lending, it can invest in crypto, precious metals, and all these other assets that are allowed by law. But the rules matter and the IRA owns the asset, not you personally. The documents need to be in the IRA's name, the money has to flow through the IRA, and you need to avoid engaging in prohibited transactions between yourself, other disqualified persons, and your IRA. Self-directed investing can give you more control, more diversification, and a better way to build long-term tax advantage wealth. And if you're ready to take control of your IRA and start investing beyond the stock market, my team at Directed IRA can help you do it. We specialize in self-directed accounts that let investors use their retirement accounts to invest in all these assets we've talked about, all inside a proper tax advantage retirement account structure. There's a link in the description below where you can book a free call with our team to help you get started in self-directing your retirement. I'm Matt Sorensen.

SPEAKER_00 28:29

I'll see you in the next one. And thank you everyone for listening. A quick disclaimer and reminder: this presentation does not constitute an attorney or CPA client relationship, and it is always in your best interest to consult competent legal and tax professionals when conducting your own personal transactions.

SPEAKER_01 28:47

We also want to make sure you know this is not investment advice or financial advice. We're just trying to give you education, ideas, and strategies you can take to your professionals or conduct your own research on. We'll see you next time.