What are the Rules for a Self-Directed IRA?
Rules and Guidelines for Withdrawals and Taxes

Self-Directed IRA Rules and Guidelines

When you're considering a Self-Directed IRA (SDIRA), these accounts' rules need to be followed closely in order to avoid any penalties. Fortunately, the rules for opening and investing with a Self-Directed IRA are fairly simple. They are the same rules that apply to standard IRAs and 401(k) plans. The only difference is the opportunity for application. In a standard IRA, investors are typically limited by their brokerage houses to only invest in stocks, bonds, and mutual funds. With a Self-Directed IRA, you can choose to invest in almost any type of alternative asset. This increased flexibility and control over your investments comes with increased responsibility. As a Self-Directed IRA account holder, you are responsible for understanding your investments and the Self-Directed IRA rules and guidelines so that your account keeps its tax-advantaged status.

So what are the rules for a Self-Directed IRA?

Self-Directed IRA investor smiling and shaking hands with a financial professional to show the importance of a good relationship with you and your financial advisor, tax professional, or Self-Directed IRA Specialist.

Rule #1
All Self-Directed IRAs Must Be Held by a Custodian

The Internal Revenue Code (IRC) Section 408 details that all IRAs must be held by a custodian, such as a bank or a trust company. For a Self-Directed IRA, you will choose a custodian who specializes in holding alternative assets. A Self-Directed IRA custodian is responsible for holding the account's investments in custody, making transactions based on the direction of the IRA account holder, complying with all IRS reporting requirements regarding the IRA including filing IRS Forms 5498 and 1099-R, and maintaining the tax-advantaged status of the IRA.

This rule also applies to a Self-Directed IRA LLC. An IRA LLC gives investors checkbook control for their IRA. The LLC has to be specially formed to adhere to all pertinent Self-Directed IRA IRS rules and regulations. One of the most frequently asked questions for this kind of account is whether or not a preexisting LLC may be used. The answer is no. The IRS requires certain elements in an IRA LLC, and these are not found in a standard business LLC.

Rule #2
Permissible Assets in a Self-Directed IRA

Theoretically, a Self-Directed IRA has very few rules about what it can invest in. The only assets mandated off-limits by ERISA are collectibles, S-Corporation stock, and life insurance settlements. Practically, this would mean that an investor cannot purchase art or antiques, even if they feel they are getting a great deal. Other assets are generally acceptable, although some might have qualifying requirements. Assets that are allowable in an SDIRA include but aren't limited to: real estate, precious metals, private placements, promissory notes, and startups.

Rule #3
Paying Taxes in a Self-Directed IRA

With most assets in a Self-Directed IRA, the tax rules allow you to avoid paying any taxes until you take a distribution. However, there are two situations where taxes may have to be paid even while the funds are being actively invested.

The first is UBIT: Unrelated Business Income Tax. If your IRA is running an active business, it could conceivably have an unfair advantage over the competition if it got a private tax break. To remedy this situation and maintain a level playing field in the commercial world at large, UBIT was enacted.

The second potential tax is UDFI - Unrelated Debt Financed Income. If you use your Self-Directed IRA to invest in a company or property and also use a loan to help finance the investment, then you will be required to pay UDFI. The part of the investment that is financed by the loan does not receive the IRA tax incentives and therefore has to pay its percentage of the tax.

Rule #4
Prohibited Transactions in a Self-Directed IRA

Prohibited transactions are perhaps the most well-known of the Self-Directed IRA rules and guidelines. Simply stated, the account holder or their close relations may not give or receive any benefit to the IRA account. An account holder acts as the non-compensated manager. Common examples of Prohibited Transactions include the account holder mowing the lawn of an IRA property, the account holder's parents offering a personal loan to the IRA, or a child of the account holder living on the property.

Rule #5
How To Make A Contribution in a Self-Directed IRA

When an IRA is self-directed, rules state that contributions can be made by writing a check and filling out a Deposit Information Form. This is true for both the Self-Directed IRA and the IRA LLC. In an IRA LLC, contributions cannot be made directly into the LLC checking account for your Self-Directed IRA; the accounts' rules dictate that contributions have to be deposited with the custodian.

Investor sitting on his phone and laptop, planning for his retirement and contributing to his Self-Directed IRA.

Rule #6
RMDs in a Self-Directed IRA

Required minimum distributions, or RMDs, are a part of every tax-deferred retirement account and, as such, fall within the Self-Directed IRA withdrawal rules. An RMD is a minimum amount the IRS requires that you withdraw from your IRA each year once you reach a certain age. The required amount does change from year to year, so it’s important to refer to a Self-Directed IRA custodian like Madison Trust, who can guide you through taking out RMDs.

Rule #7
Financing in a Self-Directed IRA

Since you will most likely be the only one investing in your asset, you need to have enough funds available in your Self-Directed IRA to purchase your asset.

If you do not have enough funds available, you may want to consider a non-recourse loan.

For example, let’s say you’re interested in a real estate investment that you need $100,000 to purchase, but your Self-Directed IRA has $75,000. You can use a non-recourse loan to cover the additional $25,000 needed to purchase the investment.

Want to Learn More about Self-Directed IRA Rules and Guidelines?

Reach out to us today and one of our Self-Directed IRA Experts will answer all of your questions.

Schedule A Call

Our Story

Madison Trust is an industry-leading Self-Directed IRA custodian with a passion for empowering individuals to gain control of their retirement investing. Learn more about our story from our President & CEO, Daniel Gleich.

Ready to Get Started? We're Here for You!

Madison Trust offers Self-Directed IRA services that are easy to get started with! Thanks to our dedicated Self-Directed IRA Specialists, you will be provided with step-by-step guidance from account setup all the way to placing your investment.

It's time to start investing in what you know and believe in with a Madison Trust Self-Directed IRA!

Self-Directed IRA Specialist at Madison Trust to show our incredible customer service.

Ready to invest in your future?

Reach out to our team, and we’ll answer all of your questions.

Your information is secure.

Trending IRA Insights

The parents of a happy daughter wonder if they can utilize their Self-Directed IRA loans to family members in need.

Lending Self-Directed IRA Loans to Family: Is it Possible?

Learn whether Self-Directed IRA loans to family members are feasible. We’ll navigate through the rules, restrictions, and rewards of this unique investment strategy.

Can a Self-Directed IRA Invest In an S-Corp?

One question we often receive is “can a Self-Directed IRA invest in an S-Corp?” While ERISA does not directly include S-Corporation shares as a prohibited asset for SDIRAs, the law that creates S-Corps does not allow it. Explore the possibility of investing in S-Corps and private businesses with an SDIRA in this blog.

Self-Directed IRAs for Natural Disaster Relief: Employing Retirement Savings for Humanitarian Aid

Applying Self-Directed IRAs for natural disaster relief can help those in need of emergency support. Learn how you can participate in restoration projects and other forms of assistance with your retirement savings.

What are the Rules for a Self-Directed IRA? Rules and Guidelines for Withdrawals and Taxes

Self-Directed IRA Rules and Guidelines

Rule #1 All Self-Directed IRAs Must Be Held by a Custodian

Rule #2 Permissible Assets in a Self-Directed IRA

Rule #3 Paying Taxes in a Self-Directed IRA

Rule #4 Prohibited Transactions in a Self-Directed IRA

Rule #5 How To Make A Contribution in a Self-Directed IRA

Rule #6RMDs in a Self-Directed IRA

Rule #7 Financing in a Self-Directed IRA