How To Avoid Paying Extra Taxes and Penalties in a Self-Directed IRA Part 1 – Collectibles
Retirement plans have a built-in incentive of tax savings. This could be a tax deferral with a Traditional IRA or full tax freedom on growth with a Roth IRA. In either case you don’t want to ruin your economic gain by doing something that the IRS will charge you for. This is especially true in Self-Directed IRA accounts. Investors have more freedom to make their money grow, but that means they also have an increased responsibility to know what the rules are. The IRS (in a great turn to consumer-friendly content) has published the main danger spots in Publication 590-B. Let’s take a look at some of these transactions and find out how to avoid them.
The Collectible Conundrum
Any Self-Directed IRA investor wants to see growth in their account, and collectibles can often provide eye-watering numbers. One example is the work of Gerhard Richter. A popular contemporary artist, his painting “A.B. Still” was sold in 1991 for $264,000. It was later auctioned off in 2020 for $33,987,500! With numbers like that, who wouldn’t want to take a chance on art? Well, apparently the IRS wouldn’t. In an effort to have retirement investors focus on more conservative assets, it is forbidden for your Self-Directed IRA to invest in any collectible. (Some experts claim that art became a prohibited investment in response to war looting. The government didn’t want this oft stolen asset to be shielded in a private retirement account. Whatever the true reason is, the reality is that your Self-Directed IRA cannot purchase art.)
Which Collectibles Are Prohibited in a Self-Directed IRA?
Now “collectible” is a fairly generic term, and can include a lot of different assets. (The case can be made that some people like collecting huge amounts of dollars in their bank accounts.) In recognition of this fact, the IRS provides an item-specific list of collectibles that are off-limits to your Self-Directed IRA. These include:
- Artworks – All types of art fall under this rule including paintings, sculptures, and installations.
- Rugs – High priced rugs are an up-and-coming investment collectible. The Clark Sickle-Leaf Carpet was sold for $33 million at an auction in 2013.
- Antiques – Would your Self-Directed IRA be interested in investing in a small washing bowl? In 2017, Sotheby’s sold the Ru Guanyao Brush Washer Bowl – a 900 year-old Chinese antique – for $37.68 million in a Hong Kong auction.
- Metals and coins – It’s hard to avoid the plethora of advertisements from companies urging you to get into gold and other metals. It’s even harder when you think about the windfall that it may mean for your Self-Directed IRA. However, most of those precious metals are off limits to you. Metals in general are prone to consumer abuse and designating them as a forbidden collectible is a legitimate move by the IRS. Still, if a Self-Directed IRA investor really wants to diversify with precious metals, the IRS allows the investment with some very tight standards. The IRS explicitly permits gold coins that are minted by the Treasury department with the weight of one, one-half, one-quarter, or one-tenth of an ounce. Other permissible metals include certain platinum and silver coins and specific types of bullion. In all cases check with a tax expert before your purchase to ascertain that it will not in any way negatively affect your Self-Directed IRA.
- Gems – Much like precious metals can experience steep climbs in price, gems can also vary based on the collector’s market. In 2016 a 14.62 carat blue diamond known as “The Oppenheimer Blue” sold for $57.5 million.
- Stamps – One of the classic collectible categories, stamps continue to fetch astounding prices at auction. A British Guiana 1c Magenta was recently sold by Sotheby’s for $8,307,000.
- Alcoholic beverages – Wine is as much a collector’s item as any of the others. A bottle of Screaming Eagle Cabernet 1992 can be yours for as little as $500,000. However, you would have to drink it or find somewhere else to put it because it can’t go in a Self-Directed IRA.
Consequences of Investing in Collectibles
If your Self-Directed IRA did invest in one of these collectibles, what would the consequences be? To start with, the amount spent on the collectible is designated as a distribution and thus incurs tax liability. Depending on the circumstances (the age of the account holder, etc.), there may also be an additional penalty of 10% for an early distribution.
Collectible Investment Options
Presumably, you now know enough to stay away from collectibles as a Self-Directed IRA asset. However, what if your passion and expertise lie in one of the collectible fields, and you would really like to take advantage of that to grow your retirement funds? Theoretically there is an available option. Although your Self-Directed IRA may not invest directly in collectibles as an asset, it may invest in a company that sells collectibles.
As we have already mentioned Sotheby’s a number of times, let’s give it one more shout-out. Between the years of 1988 and 2019, Sotheby’s was a publicly traded company. It was listed on the New York Stock Exchange and traded under the ticker symbol “BID”. At that time, it would have been possible and perfectly legal to invest your Self-Directed IRA in Sotheby stock. Even though the company made its profit by auctioning collectibles, your IRA was not investing in the collectibles themselves. Rather it was investing one level up in the company that dealt with the collectibles. From an IRS perspective, the Sotheby stock was as legal as any other stock investment.
Sotheby is no longer publicly traded, but it’s still possible to find other publicly traded “collectible” options for your Self-Directed IRA. There are a number of wine and liquor companies which are publicly traded. There are even more gold and precious metal stocks that you can invest in. And certainly there is no shortage of gem and diamond companies that are listed on the market. Obviously, you’ll have no say in the asset acquisitions of these companies, but you can use your collectible expertise to evaluate them as a business and determine their chance of success.
Do you have more questions about collectibles?