Self-directed IRAs: opportunities and pitfalls you should know.

• Author: Jones, Michael J.
• Position: Investment strategies

The Employee Retirement Income and Security Act of 1974 introduced tax-deferred retirement accounts and the workers who have accumulated such accounts are retiring in growing numbers. Many choose to roll over funds from employer-sponsored plan accounts to an IRA--either a trusteed IRA (held by a bank or trust company) or a self-directed IRA, where the IRA owner has primary responsibility for making investment choices.

Not everyone wants to invest in marketable securities, however. So-called "alternative investments" are being sought out by IRA owners out of preferences for other asset classes--such as real estate--or a desire to produce better returns.

Many such investments may be held in IRAs, but some types of investments aren't permissible. And, prohibited transactions must be avoided because they can instantly and irretrievably kill an IRA, causing a deemed distribution resulting in imposition of income taxes on the entire value of the IRA.

Unacceptable Investments

There are only a few restrictions on what an IRA can invest in. No part of an IRA may be invested in any life insurance contract. Also, an investment in certain "collectibles" is treated as an IRA distribution. The amount of the deemed distribution is the IRA's cost of acquiring the collectible.

Prohibited "collectibles" are listed in Internal Revenue Code Sec. 408(m)--which include any work of art, rug or antique, metal or gem, stamp or coin, alcoholic beverage or any other tangible personal property specified by the secretary for purposes of this subsection.

In the case of coins and bullion that may be held by an IRA, those assets must be in the possession of the IRA trustee or custodian to qualify as exceptions to the prohibition on investing in collectibles.

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IRC Sec. 408(m) (3) and IRS Publication 590 provide a list of acceptable investments that are not treated as prohibited collectibles. These include certain coins, as well as any gold, silver, platinum or palladium bullion of a fineness equal to, or exceeding the minimum, fineness that a contract market (as described in sec. 7 of the Commodity Exchange Act, 7 U.S.C. 7) requires for metals which may be delivered in satisfaction of a regulated futures contract.

Owning stock in an S corp isn't forbidden, but an IRA is not a permitted shareholder of an S corp, according to Revenue Ruling 92-73, 1992-2 C.B. 224. Nor is a Roth IRA a permitted S corp shareholder [Taproot Administrative Services, Inc. s...