What’s Allowed and What’s Not in Self-Directed IRAs?

Some types of investments are not permitted because of rules implemented by the IRA sponsor, rather than formal IRS rules. That means it’s important to review the IRA custodian agreement before making any investment decisions.

Practical Considerations: Reporting to the IRS

Every year, an IRA must report its value to the IRS. The IRA custodian is responsible for reporting the value of account assets on Form 4598. For traditional investments, like stocks and bonds, the investment’s price at the close of the day Dec. 31 is reported.

In self-directed accounts with nontraditional assets, the asset’s fair market value is not so readily available. The IRA owner will have to provide information on the investment’s value to the IRA custodian — and the IRS offers no guidance on what constitutes an acceptable form of valuation. .

Many IRA custodians will require an independent appraisal each year, the cost of which is paid by the IRA or its owner. Other valuation methods, including use of comparative market analysis for real estate investments, may be acceptable.

It’s important that any appraisal be conducted by an independent appraiser. If the IRA owner or even certain related parties conduct the appraisal, it’s possible that the act could violate self-dealing rules and that the IRA would lose its tax-favored status.

These valuation rules are important because account value is used to set minimum distribution amounts once owners reach their required beginning date. Proper valuation is also important for purposes of Roth conversions or in-kind distributions.

Clients should also remember that the IRA is an entity that’s separate from the client themselves. Assets held within the IRA must be titled in the IRA custodian’s name, not the account owner’s name. If the account owner is named as the asset’s owner on the title, the asset is treated as though it was distributed to the owner and, thus, is taxable income and subject to penalties.

Conclusion

It’s critical to consult a qualified advisor before engaging in any self-directed IRA investment strategy. The rules are complicated — and one false move could cause the entire account to lose its IRA status.

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