Preface: SD-IRAs are a complex taxation field. Appropriate compliance and risk mitigation begins with an awareness that tax risks exists. This blog is help you be aware of the facts about SD-IRA’s and prevent taxing mistakes.

SD-IRA Tax Compliance is Worth the Investment

Are you a vanguard retirement investor with a self-directed IRA (SD-IRA)? It’s like buying a car, you’re advised to shop wisely, and opinions and options vary. SD-IRAS are not a new investment feature. They’ve been in existence for years. Yet, popularity is now increasing, and along with that growing optimism on the vanguard retirement investing option, is a need to understand tax compliance, and non-compliance tax risks.

The facts are that less than 50% of SD-IRA investors properly handle legal and tax compliance issues. More concerning, is the fact, that many of the investors are oblivious that problems even exist. If your retirement funds are in an SD-IRA make sure you’ve invested in the proper advice to get and stay in compliance with tax laws. A prohibited transaction can invalidate the IRA and tax penalties can reach 100%. Ideally, you should understand the tax risks before investing. Let’s look at two hypothetical working examples to begin to paint the picture of what the tax risks look like.

Ulrich and Louisa’s SD-IRA will be our first hypothetical risk assessment working example. Ulrich and Louisa saved up $80,000 in a traditional IRA before Ulrich heard how he could transfer the funds into a SD-IRA and invest in commercial real estate. He and several friends pooled their funds and bought a $1,525,000 commercial office complex, with a $700,000 loan from the local bank. Soon they were earning 15% on their money with 15 year triple net lease tenants, and looking for the next deal.

When sitting with the financial advisor one day, Ulrich and Louisa’s advisor suggested they check the compliance risks on the investments, namely the SD-IRA. He said the vanguard investment fields risk is often hidden to most. They listened to the advice. After contacting there CPA, they became aware that the personal guarantee on the SD-IRA bank loan was a prohibited transaction under IRC Section 4975. In addition, the CPA told them that a certain percentage of the rental income was subject to unrelated debt-financed income under IRC Section 514. This subject the SD-IRA investment to a 990-T filing and an imposed tax on the pro-rata SD-IRA earnings. Ulrich and Louisa were surprised to learn that the noncompliance tax risks would result in a likely tax penalty in excess of $100,000 on the SD-IRA assets.

Amos’s SD-IRA will our second hypothetical risk assessment working example. Amos was opposed to stock market investing with IRA and when he learned that he could invest in a furniture manufacturing business he did some online research and found an SD-IRA custodian online with the lowest rates, transferred his IRA, and invested $250,000 in Suites R Us, L3C. The first year was very successful. Soon Amos and his wife agreed that Amos should work daily at Suites R Us to help the business keep pace since it was so developing so successfully. When Amos filed his taxes that year, his IRA contribution was questioned by the CPA since Amos said he was investing in his own business, and saving on taxes too. The CPA said he might have a compliance risk. When they assessed the SD-IRA, Amos was surprised to learn that he was subject to unrelated business income tax and 990-T filing with his SD-IRA under IRC 514, and payment of appropriate taxes. He also discovered his employment in the business subject his SD-IRA investment to a prohibited transaction under IRC 4975. Combined this risk resulted in more than a 30% tax on the amounts involved, plus accuracy related penalties; or more than $97,000 in tax. 

These are only two hypothetical working examples on SD-IRA risks, but realistic. If you are thinking of leveraging a SD-IRA for your retirement assets, you’re advised to invest the time and resources to see to appropriate compliance. Appropriate compliance is simply understanding the complex SD-IRA tax laws and regulations and  compliance adherence. Often a tax expert, say either a CPA or attorney, can help you make sense of the tax risks.