The Flexible IRA Option Your Adviser Will Never Tell You About

Most self-directed IRAs are just multiple choice. A real self-directed IRA can go after nontraditional investments, and the potential is tremendous.

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When you set up an individual retirement account, you're usually given a list of investment choices -- mostly stock-based funds, and some bond funds. Many financial professionals call this a self-directed IRA, but it's really just a multiple-choice IRA: "You can invest in anything you like, as long as we approve it and control the funds."

However, a real self-directed IRA can be set up with an administrator who is approved to handle nontraditional investments, such as real estate, private loans, tax liens, limited liability corporations, options and other non-stock and non-bond investments. These IRA are for the active and educated investor, not for the investor who just wants to put money away and turn the management over to brokers or financial advisers. It's more work, but the potential with this type of account is tremendous.

Let's consider a few hypothetical investments.
  • If you bought a home for $50,000 using funds from your self-directed IRA and leased the property out for $900 a month, your net cash flow wouldn't be taxable. If your net monthly positive cash flow was $550 (a reasonable figure), your $6,600 would either be tax-deferred or tax-free depending on the type of IRA you had used (traditional or Roth) to purchase the property. If you leased it for five years, that would mean $33,000 of positive cash flow would be in your IRA tax-free -- plus, you still own the home. If you sold the home for $80,000, your net profit would be tax-deferred as well. In five years, you would have made $33,000 in cash flow plus $30,000 in appreciation, for a total of $63,000 of nontaxable profit in your IRA. And, yes, you can still take advantage of these types of deals.
  • You could buy a fixer upper for $50,000 and put $25,000 in repairs for a total investment of $75,000. If you flipped that property for $110,000 and netted $105,000 after sale expenses, that would be a $30,000 profit. That profit will be tax-deferred -- and you can repeat the process. If you had flipped the property outside of your IRA, you would be subject to short-term capital gains taxes, payable at your ordinary income level. You would have had to give $10,000 to Uncle Sam, and you'd have been left with just $20,000 after tax profit.
A More Complicated Scenario

You could buy a property and sell it with a wraparound mortgage. Let's say you find a fixer-upper where the seller is willing to take a small down payment and carry the balance of his equity in a note and mortgage. The seller will take a payment for his equity for a number of years. Say the purchase price is $100,000, and your down payment (from your IRA) is $10,000. You have a $90,000 mortgage payable to the seller with a 30-year amortization at 5 percent, with a five-year balloon payment, giving you a principle and interest payment of $483.

You later sell with these terms:
  • $125,000 purchase price.
  • $20,000 down payment (giving your IRA the $10,000 investment back plus a $10,000 profit).
  • $105,000 wraparound mortgage payable to you with a 30-year amortization at 7 percent, with a four-year balloon payment, giving you a $699 payment coming in every month.
  • You are responsible for the underlying payment of $483, giving you a positive cash flow of $216 per month or $2,592 per year. This will be a four-year net cash flow of $10,368, plus the $10,000 profit up front.
  • Also in four years, you will still be owed $100,000 but will only owe the underlying seller $84,000, giving you another profit on the back side of the sale of $16,000.
Let's do a little back-of-the-envelope calculating to see if it's worth your time to get educated on the ins and outs of this type of transaction. The profit over four years is $10,000 up front (the difference between the down payment you made and the down payment collected upon sale), $10,368 of positive cash flow and $16,000 of back end profit when loans are paid off for a $36,368 net profit for our IRA on a $10,000 investment that we received back in the first 90 days.

The Dodd-Frank Act mandates certain disclosure and actions be taken if you deal with private mortgages and financing. Get qualified help. Balloon mortgages are not acceptable anymore when selling to an ordinary buyer, but could be fine if you are selling to another investor.

In a transaction like this one, you would use borrowed money in the form of a seller-held mortgage. This would make some of your profit taxable out of the IRA, but the rest of the money would get to stay there tax-deferred. Your IRA can borrow money, but it has to be non-recourse debt, which means there are no personal guarantees on the money you borrow. If you don't pay the seller, his or her only recourse is to foreclose on the house; he can't come after the IRA or you personally for any deficiencies. Consult a highly knowledgeable real estate professional and an attorney to help you set this up properly. You should do research and get more training on these types of deals as well.

Some Limits Apply

There are some things you are not allowed to do with your IRA. Among them:
  • You can't invest in collectibles such as stamps, coins, comics or baseball cards.
  • You can't self-deal, which means no loaning money to yourself.
  • You can't loan money nor do business with IRA money with anyone in your direct linear family chain, such as your spouse, children, grandchildren and parents. Your IRA may do business with family members not in your direct lineage, such as siblings, aunts and uncles).
Several companies offer self-directed IRAs; two of the bigger ones are Equity Trust and Entrust. Before you go this route, it is important to do your homework on which is a good fit for you and what you are trying to accomplish. But if you're up for the challenge of nontraditional investments, you should take a close look at this fantastic opportunity to be fully in control of your IRA.

John Jamieson is the best-selling author of "The Perpetual Wealth System." Check out his Video of the Week.

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Elizabeth Trebotich

The simple answer is educating yourself. Articles like this are fantastic to get the word out there that we have this option, but to use it successfully requires some genuine due diligence on both the strategy and the investment. Not everyone is born to be a flipper and not everyone knows about precious metals, but there are ways to invest in real estate and other alternatives through a SDIRA that are just as passive as the stock market yet yield a MUCH higher return. Anything is risky if you don't educate yourself well enough to do it right. Personally, I own passive rental real estate in my SDIRA and I used non-recourse leverage to do it. I worked with my CPA, my SDIRA custodian and the turnkey provider from whom I bought the property to become well-versed in the rules, requirements and tax implications so I know I will use this strategy correctly... and I get to see over $400 in positive (port all expenses) cashflow go into my IRA every month per property I own without having to do anything at all "landlordy." I have even been able to buy properties in different markets throughout the US that are better for investment than where I live. I am diversified, I am hedging my portfolio against inflation with an asset whose value can never go to $0, and taking the small amount of time to learn to do it right has yielded far more than my stock portfolio ever did with the peace of mind of a 'contracted return' (annual lease on my properties). This may not be for everyone, but if you want to make a better return in your retirement account then educate yourself.

February 25 2015 at 11:03 AM Report abuse rate up rate down Reply
Nick Barker

I love some of the comments about the work. The idea with a self directed IRA is that you can invest your retirement account how you want. Of course you can do all of the work yourself if you want but like many others have said you can also hire a reputable firm to help you with your self directed IRA.While you typically have to figure out what you want to invest in they typically handle most of the tax related documents and such. You choose the investments while they do the paperwork. It really isn't as hard as it seems. When investing with a self directed IRA there are rules you should be aware of though. For more on the rules to self directed IRA investing check out ->

September 12 2014 at 3:57 PM Report abuse +1 rate up rate down Reply
Josh Moore

I'm glad to see so many articles on this subject. You mentioned a custodian (ETC) and an administrator (Entrust) but didn't mention the IRA LLC format - this gives investors ALL the freedoms allowed under IRA law, not just those given by any particular custodian or administrator.

For more info on a TRUE self-directed IRA visit

June 17 2014 at 1:18 PM Report abuse rate up rate down Reply
Jon Kopp

ray - that's why you work with companies designed to do the work for you. it's quite simple actually, and it'll round out your portfolio quite nicely. i'm a fan of growth equity group

June 10 2014 at 10:53 AM Report abuse +1 rate up rate down Reply
crazy ray

Sounds like a total defeat of the idea of retirement. If you have to do this much work, you might as well keep working.

June 01 2014 at 8:59 PM Report abuse +1 rate up rate down Reply
Dean DeTar

If you use leverage to buy a property within an SDIRA you are liable for the UBIT taxes generated within the IRA. Doesn't mean it's a bad deal, it's just not tax deferred like stocks and bonds within an IRA.

June 01 2014 at 5:56 PM Report abuse +1 rate up rate down Reply

My "financial advisor" used to call me once and sometimes twice a week as soon as all my liquid money was finally invested ..the phone calls did my investments ..2007..lost alot.The only smart thing I did was listen to Rubini who said the problem is going to get worse after Bear Sterns collapsed....Kudrow on the TV was saying its over and the stock market,that great American institution is safe now that the stock rebounded after the Bear Sterns got sorted out....well I bailed out of mutual funds on Rubini's advise and saved my 401K from further everything caved in....three things I learned..albeit too late....Academics want to get it right because it's an ego thing ..FInancial advisers don't care as long as they get your money..A tip one horse is more trustworthy then a tip on a stock...the tipster loses money as the odds go down.... the stock tipster gains and then dumps as soon as the stock goes up.......

June 01 2014 at 3:19 PM Report abuse rate up rate down Reply

Anyone who understands this jibberish must be on drugs.

June 01 2014 at 2:44 PM Report abuse +1 rate up rate down Reply

Wow! How old is this article??? This strategy proved to be very risky and definitely not a good idea many years ago. There is a reason your Financial Advisor didn't tell you about building your retirement account this way. NOT a smart move. The real estate market whether renting or buying is a big enough gamble without throwing your retirement funds in to the mix.

June 01 2014 at 7:00 AM Report abuse +1 rate up rate down Reply
1 reply to CommonSense's comment
Josh Moore

Uh, if I recall, when the real estate market was down stocks, bonds and mutual funds didn't pan out to well either. At least those in real estate still have a property, those on Wall Street went poof.

June 17 2014 at 1:11 PM Report abuse rate up rate down Reply
Saint Michael

After paying expenses and taking the depreciation deduction, rental properties are already almost tax free. In addition, one can avoid capital gains taxes via 1031 exchanges. I wish the article would have given details of high tax investments, such as tax liens and making loans.

May 31 2014 at 9:49 PM Report abuse rate up rate down Reply