Self-directed IRAs allow individuals to direct their IRA investments into a broader range of assets, including real estate, private companies, and other non-traditional investments. However, there are specific tax implications and rules that must be followed to maintain the tax-exempt status of these accounts.
- Prohibited Transactions: Engaging in prohibited transactions can cause a Self-directed IRA to lose its tax-exempt status. Prohibited transactions include self-dealing, where the IRA owner uses the IRA assets for personal benefit.
- Tax Treatment of Distributions: Distributions from traditional IRAs are generally taxable as ordinary income, while qualified distributions from Roth IRAs are tax-free. Contributions to Roth IRAs are not tax-deductible, but earnings and qualified distributions are tax-free.
- Investment in LLCs and Real Estate: Self-directed IRAs can invest in LLCs and real estate, but the IRA owner must avoid prohibited transactions.
- Early Withdrawals and Penalties: Early withdrawals from traditional and Roth IRAs before age 59½ typically incur a 10% penalty, except for inherited IRAs, which do not have this penalty.
- Tax Deferral and Growth: The primary benefit of IRAs, including Self-Directed IRAs, is the deferral of income tax on investment gains until distribution. This allows the investment account to grow undiminished by taxes until the time of payout.
In summary, while Self-directed IRAs offer greater investment flexibility, they come with strict rules to avoid prohibited transactions and maintain tax-exempt status. Violations can result in significant tax liabilities and penalties.