Going the Non-Traditional
nice thing about IRAs — including SEP IRAs, SIMPLE IRAs, and
Roth IRAs — is that you have some freedom to manage the
investments in them as you see fit. So you’re not necessarily
restricted to investing only in traditional retirement account
assets such as publicly traded stocks, bonds, mutual funds,
Treasuries, and money market instruments.
In fact, the Tax Code allows you to invest your IRA dollars
in almost anything within
limits, other than life
insurance and collectibles. For this purpose, collectibles
include works of art, rugs, antiques, metals, gems, jewelry,
stamps, coins, alcoholic beverages, and certain other tangible
you are interested in alternative IRA assets, it's
generally prudent to keep them segregated in designated
accounts. Keep your other IRA balances devoted to
traditional retirement account investments.
Avoid Unrelated Business
Certain types of IRA investments can potentially trigger
unrelated business taxable income (UBTI). When this
happens, your IRA may owe federal income tax, which
really defeats the whole purpose of the account. The
UBTI rules are intended to prevent IRAs from investing
in income-producing businesses via direct ownership or
via ownership of a partnership or LLC interest. An
example might include using an IRA to buy an interest in
a cattle breeding partnership.
As mentioned in
this article, leveraged assets can also generate UBTI
for an IRA. So investing in a partnership that owns
leveraged assets could cause UBTI problems.
The good news: Rental
income from real property is generally excluded from the
definition of UBTI (assuming the property is not
mortgaged). Therefore, using your IRA to buy unmortgaged
rental real estate and collect the resulting net rental
income should not trigger the UBTI
Similarly, using your IRA to buy
oil and gas royalty ownership interests won't trigger
UBTI (assuming the interests are not
Since this involves the tax code, there are exceptions to
the exceptions. For example, one exception to the “no
collectibles rule” allows an IRA to buy certain gold and
silver coins minted by the United States or by U.S. states.
Another exception says your IRA can invest in high quality
gold, silver, platinum, and palladium bullion. However, any
such bullion must be kept in the physical possession of your
Fair enough. Beyond what we've just described, however, you
won’t find very many clear answers on the types of
“alternative investments” that are permissible for your IRA
and the types that are banned. With that thought in mind,
here’s a quick summary of what you can and can’t do.
Watch Out for These
There are "prohibited transaction rules" intended to
prevent you from using IRA money to engage in certain
"self-dealing" transactions, which are deemed to be
inconsistent with an IRA’s status as a tax-favored retirement
Also, certain types of investments could cause your IRA to
be taxed on so-called unrelated business taxable income
(UBTI). That would have a negative effect because the
advantage of tax deferral — or outright tax avoidance in the
case of a Roth IRA — is the biggest selling point of
individual retirement accounts. (See right-hand box for more
information on UBTI.)
Because of the risks of running afoul of the prohibited
transaction and UBTI rules and due to vague official guidance
on permissible assets, many IRA trustees won’t allow these
accounts to hold anything other than traditional retirement
investments. That said, some companies specialize in
functioning as IRA trustees for people who insist on
alternative investments. If you are one of those people,
please keep reading because suitable alternative investments,
such as the following, can be held in what is often referred
to as a "self-directed IRA:"
Stock from an initial public
Closely held stock.
Some real estate.
Options to buy real estate.
Oil and gas royalty interests.
Mortgages or loans to be held for
This is not an exhaustive list. As you can see, some of
these alternative investments are not liquid. This can present
problems. If you have too much of your account tied up in
illiquid investments, you won’t be able to dip into your IRA
for cash when you need it. In particular, it is important
to maintain enough liquidity to take your annual required
minimum distributions after reaching age 70 1/2. Why? Because
if you fail to take these minimum distributions, the IRS can
penalize you for 50 percent of the difference between what you
should have withdrawn from your account each year and what you
actually withdrew (if anything). Thankfully, Roth IRAs are not
subject to the required minimum distribution rules until after
the account owner dies.
Real Estate as an IRA
In general, you can use your IRA to invest in real estate.
You may find this idea attractive — especially if you think
the stock market is overvalued, real estate is a better deal,
and you have been disheartened by the relatively low rates of
return currently offered by most traditional fixed income
Your IRA must own the real estate strictly as an
investment, which means no use by you or certain family
members. The IRA trustee must hold legal title to the
property. Finally, your IRA must have sufficient liquid assets
(either from other investments in the account or from your
annual contributions) to cover any costs associated with
owning and operating the real estate.
Remember: You lose some tax advantages by holding
real estate in a traditional IRA, SEP IRA, or SIMPLE IRA.
Specifically, you won’t benefit from the 15 percent maximum
federal income tax rate on long-term real estate gains (25
percent for long-term gains attributable to depreciation), and
you can’t claim current deductions for mortgage interest,
property taxes, depreciation, and so forth which you can
typically write off on your Form 1040. However, if you use a
Roth IRA to invest in real estate, the property can be sold
with the gain eventually distributed federal-income-tax-free
(and maybe state-income-tax-free too) to you or your heirs,
assuming the rules for tax-free Roth IRA distributions are
Unmortgaged rental properties are a potentially good choice
for IRAs. Real estate mutual funds and REITs are also viable
Mortgaged real estate is less advisable, because leveraged
property can potentially create UBTI and a resulting federal
income tax bill for your IRA. Bottom line: your IRA must have
enough liquidity to service the debt, pay for any other
expenses related to the property, and pay any UBTI tax bills.
If you still insist in investing in mortgaged property, the
debt must be in the name of the IRA trustee and not in your
name. Also, you cannot be secondarily liable for mortgages
against property owned by your IRA.
Using an IRA to invest in a real estate partnership may
also trigger UBTI problems.
Bottom Line: Consult with your tax adviser before
using your IRA to invest in mortgaged real estate or a real
estate partnership. You want to make sure the investment won’t
create UBTI problems. For a large transaction, ask your tax
adviser about getting a government ruling on this issue.
You must be careful that alternative IRA investments don’t
run afoul of the prohibited transaction rules. If these rules
are broken, your IRA’s tax-favored status may be lost. If that
happens, your entire IRA balance would become taxable. To add
insult to injury, you could also be hit with 10 percent
penalty tax if you’re under age 59 1/2
In a nutshell, the prohibited transaction rules are
primarily intended to prevent "self dealing" where the IRA
owner uses the account’s money to meet personal financial
objectives that are considered by the IRS to be inconsistent
with the IRA's status as a tax-favored retirement account.
Unfortunately, trying to interpret this area of the tax law is
complicated. If you’re audited and the IRS discovers your IRA
has engaged in a questionable transaction, the IRS and
possibly the Department of Labor (which also has jurisdiction
over IRAs) will examine the “facts and circumstances” to
determine whether the transaction violated the rules. Examples
of what the IRS (and the Department of Labor) may consider to
be prohibited transactions include having your IRA:
Buy stock or other assets from you or
sell them to you.
Lease assets from you or to you.
Buy stock in a corporation in which
you have a controlling interest.
Lend to you or borrow from you.
Engage in transactions with certain
related parties or family members.
On the other hand, it should generally be okay to have your
Invest in an initial public offering
or closely held stock (assuming there’s no connection to
you, certain related parties or family members).
Invest in real estate (as discussed
Invest in oil and gas royalty
interests (assuming there’s no connection to you, certain
related parties or family members).
Buy publicly traded stock options and
exchange traded funds (ETFs).
Invest in options to buy real estate
(assuming there’s no connection to you, certain related
parties or family members).
Issue mortgages or loans to be held
for investment (assuming there’s no connection to you,
certain related parties or family members).
Finding a Trustee
to Handle Alternative Investments
As mentioned earlier, many of the best-known IRA trustees
will not allow alternative investments for accounts under
their supervision. So taxpayers may have to search for a
trustee that will permit what they have in mind (for example,
having an IRA invest in real estate and collect the
rents). Suitable trustees are out there. In fact,
functioning as a trustee for IRAs with alternative investments
has become a bit of an industry in and of itself.
Of course, once potential trustees have been
identified, taxpayers and their tax advisers should perform
“due diligence” to make sure they are reputable and check
their fee schedules. Having an IRA with alternative
investments inevitably costs more than one with garden variety
retirement plan investments. Hopefully, the alternative
investments will perform well enough to cover the extra costs
and then some.
As you can see, it’s true that IRAs (including SEP IRAs,
SIMPLE IRAs, and Roth IRAs) can be used to hold a variety
of nonstandard investments. However, this is a complex subject
and there are many traps to avoid. Get your tax pro involved
before committing to alternative investments with
your retirement money.