Written By: Ian Robertson
Key Points
- Typically, Self-Directed IRAs are not subject to annual taxes since most alternative investments are passive.
- It’s important to take time to consider the possible ways to lower your tax bill and save for retirement.
- The IRS offers taxpayers tools that can make their filing easier, such as an interactive tax assistant, refund tracker, and a variety of consumer-friendly educational articles.
- Madison Trust’s Self-Directed IRA Specialists are here to answer your questions regarding self-directed investing.
Although not a favorite season for some, tax season is here and in full swing! This year's tax filing deadline is Tuesday April 15, 2025.
Understanding tax rules is important for both young taxpayers and retirees since decisions you make now can affect your future tax bill. Whether you are filing your tax return yourself or are working with a financial professional, it is critical to review the IRS’s tax rules so you are properly prepared to file and can maximize potential tax savings. Here are a few points to keep in mind as you complete your tax return:
Tax Considerations for Self-Directed IRAs
Unrelated Business Income Tax (UBIT) and Unrelated Debt Financed Income (UDFI)
Typically, standard IRAs and Self-Directed IRAs (SDIRAs) are not subject to annual taxation. However, some active investments, such as a real estate fix-and-flip or a business that sells goods and services, may incur UBIT (Unrelated Business Income Tax).
Another occurrence that may cause your Self-Directed IRA to be subject to tax is when leverage (such as a non-recourse loan) is used to finance an investment in your IRA. In this case, your IRA would be subject to UDFI (Unrelated Debt Financed Income) tax.
In both cases, Form 990-T must be filed and all taxes must be paid with IRA funds (using personal funds would be a prohibited transaction).
Tax Forms
Form 5498
Although taxes are not typically due on your Self-Directed IRA funds, the IRS generally requires account holders to file an annual valuation form. IRS Form 5498 reports the funds received in your account such as contributions, Roth Conversions, rollovers, and recharacterizations as well as the fair market value of your account.
As the account owner, it is your duty to calculate the fair market value of your account as of December 31. When this total is determined, you will report it to your Self-Directed IRA custodian and then they will file Form 5498 with the IRS by May 31 of the following year.
Form 1099-R
This form is used to inform the IRS that funds or assets left your IRA. Common events that generate Form 1099-R include a distribution, Roth Conversion, recharacterization, or rollover. Madison Trust will mail you the form by January 31 of the calendar year following the taxable event.
For more information regarding the tax forms for your Self-Directed IRA, please visit the tax forms FAQ page and our blog that discusses five Self-Directed IRA tax forms worth getting aquainted with.
3 Ways You Can Lower Your Tax Bill by Contributing to Retirement
1. Contributing to Your Self-Directed IRA
Depending on your Self-Directed IRA account type, tax benefits will be received at different times. If you have a Self-Directed Traditional IRA, you can lower your income tax owed when you contribute to your account. If you have a Self-Directed Roth IRA, you pay taxes upfront, but your investments grow tax free.
After you reach age 50, you are eligible to make catch-up contributions to your retirement accounts. This can in turn lower the amount of taxable income, depending on the account type you are contributing to.
2. Withdrawing Strategically
Another way you may lower your tax bill is to make strategic withdrawals. To ensure no tax consequences, you may withdraw funds from your Traditional IRA after age 59 ½. In a Roth IRA, all contributions can be taken out tax-free at any time, but earnings cannot be withdrawn until age 59 ½ and the 5-Year-Rule is met. If you are in a lower tax bracket now than you think you will be in retirement, consider withdrawing more now so you can pay fewer overall taxes.
In addition, Self-Directed Traditional IRA and 401(k) account holders over the age of 73 must take required minimum distributions (RMDs) and pay income tax on each withdrawal. However, you may consider making a qualified charitable distribution to avoid this income tax and the donation satisfies the RMD requirement.
3. Saving Your Tax Refund for Retirement
If/when you receive your tax refund, consider using those funds to contribute to your retirement account to boost your overall savings. This refund can be used to reduce next year’s tax bill or, if you meet the IRA contribution deadline, your current tax bill.
Utilizing the IRS's Tools
The IRS’ website offers a lot of practical, easy-to-read articles and other tools that can benefit taxpayers. If you are looking for some of the latest developments, you can check out the IRS Newsroom and IRS Current Tax Tips. Here are a few tools that may affect your tax preparation:
Create an Online Account with the IRS
This gives you access to your personal tax information, tax return transcripts, payment history, notices, prior-year adjusted gross income, power of attorney information, etc.
Interactive Tax Assistant
This tool answers common tax questions and can determine if the income you received is taxable or if the taxpayer is eligible to claim certain credits or deductions. The information you submit is anonymous and only used to answer your question
IRS Free File
This lets the user choose which software platform is best for their needs and guides them through the entire filing process. It's safe, easy and no cost to you.
Where’s My Refund?
Once your taxes are filed, you can use this tool to check the status of your refund. Your status will be return received, refund approved, or refund sent.
Find a Tax Professional Page
Use this directory to find Federal Tax Return Preparers with credentials and select qualifications.
Conclusion: Let's Tie It All Up
As you prepare your tax return this year, take time to consider what taxes you may be subject to and how you can lower your tax bill by contributing to retirement in a Self-Directed IRA. Also, be sure to check out the free tax tools the IRS provides American taxpayers and to speak to a tax professional with any questions.
Madison Trust's Self-Directed IRA Specialists are knowledgeable and can answer all your questions about self-directed investing. Schedule a free discovery call today to learn more about investing with a Self-Directed IRA!
