Frequently Asked Questions
Provident believes that educated consumers make the best clients. There is very little information available on self-directed IRAs; and what you can find may not be very accurate. Provident is the nation’s leading educator on self-directed IRA investing. We have created the Education Center to help you better understand this opportunity; to determine whether to start the journey into this new world of investment.
How Do I …
- Use my Account Portal?
- Initiate a transfer-in to Provident Trust Group?
- Initiate a transfer-out from Provident Trust Group?
- Change or update my contact information
- Change or update my beneficiary information?
- Understand RMDs?
- Know if it’s a Prohibited Transaction?
Want to learn more about Self-Directed IRAs?
Take a look at some articles and publications that explain the process!
Frequently Asked Questions
- How do I determine the Fair Market Value (FMV) of my asset?
- What supporting documents are needed for my investment?
- Why do I need a custodian for my IRA?
- Why are there fees associated with my account?
- Who is eligible for a Roth IRA?
- What are the benefits of a Roth IRA?
- Why create an LLC to hold my IRA assets?
- What is UBTI & UDFI?
- What is a prohibited transaction?
- What is a disqualified person?
- What types of accounts can I self-direct?
- Why haven’t I heard of this before?
- Can I purchase real estate that I or my corporation already owns with my self-directed IRA?
- Can I invest funds in real estate from a self-directed IRA using an LLC?
- Can I obtain a mortgage to invest in a property with a self-directed IRA?
- What is a non-recourse loan?
- Can my IRA invest with other partners, including myself?
- Can Provident provide tax or legal advice regarding your investment?
- What’s special about the Solo 401k?
How do I determine the Fair Market Value (FMV) of my Asset?
Provident clients typically hold alternative investments in their accounts with us. This makes it hard to determine the value of some of these assets. To assist you in determining the value your assets, you can view Provident’s valuation policy here.
What supporting documents are needed for my investment?
Documents vary based on the investment type. Please refer to our Direction of Investment form to see what type of documents are required (Section 3).
Why do I need a custodian for my IRA?
The IRS requires a custodian for self-directed retirement accounts. Provident Trust Group is your passive custodian that takes direction from you, the client. We administer your self-directed retirement account, process your asset paperwork, and ensure that your retirement account is properly reported according to IRS regulations. As your custodian, Provident Trust Group is not in a position to offer legal advice and is not your legal advisor. To ensure that your legal rights are preserved, you should consult an attorney.
Provident Trust Group is an independent, directed, non-discretionary trust company, licensed and bonded for the purpose of trustee, escrow, administrator, and custodian services for customer accounts and client self-directed retirement plans established under Section 408 of the Internal Revenue Code. Provident Trust Group does not sell, promote, endorse, guarantee, or provide legal, financial, or tax advice with respect to investments, products, or transactions.
Why are there fees associated with my account?
Provident assesses a fee to administer the account for the account holder. We do not receive a fee on your investment. Administration duties include the accounting for your investment, required IRS and state filings, facilitation of your investment, distributions requests, and compliance.
Who is eligible for a Roth IRA?
Who is eligible for a Roth IRA?You are able to establish a Roth IRA simply by making a regular contribution to a Roth IRA, or by converting a Traditional IRA into a Roth IRA. That’s it! You might also be able to contribute to a Roth IRA even if you participate in an Employer Sponsored Retirement Plan. Contribution limits can be as much as $5,000 for 2010 or 2011 ($6,000 if you’re over age 50).
But, proceed with caution! There are two requirements, before being eligible:
- You or your spouse must have qualifying income at least equal to the amount contributed.
- Your Modified Adjusted Gross Income (MAGI) cannot exceed certain limits.
What are the benefits of a Roth IRA?
Although the Roth IRA does not provide a deduction for contributions, it does provide some benefits that Traditional Retirement Accounts don’t. If you’re eligible, all earnings are tax free when you or your beneficiary, withdraw them, there is no distribution penalty on certain withdrawals, and there is no Required Minimum Distribution after age 70½.
Since your investment earnings are not taxable, and you don’t get a deduction when you contribute to a Roth IRA, and depending on your financial situation, you should ask yourself a few questions to help you decide. What is more important to you? How long will it be before you need to take a distribution from your IRA? What will your tax bracket be when you do take a distribution? What type of earnings will you receive on your IRA until that time?
By contributing more, earlier, your Roth IRA will add greater tax leverage to your retirement savings, since it holds after-tax dollars. And since it’s a Roth IRA, you’re not subject to take minimum distributions when you reach 70½ which will allow your earnings to grow tax free, longer.
Why create an LLC to hold my IRA assets?
IRA LLCs have become an increasingly popular investment for self-directed IRA Investors. An IRA LLC is a name for a process where a Self-Directed IRA invests in a newly formed LLC. In most cases, the LLC is owned 100% by the Self-Directed IRA and where the IRA owner serves as manger. There are many benefits to using this vehicle for your self-directed investments. These benefits can include:
- Checkbook control: The IRA LLC allows you to make timely investments into assets like real estate, tax liens, and foreclosures that otherwise would be very time consuming through a custodian.
- Limited Custodial Fees: Regardless of how much money you have, or the amount of investments you make, an IRA LLC should not have to pay any transactional, asset or holding fees.
- True Diversification: Purchase traditional investments like stocks, bonds and mutual funds in addition to real estate, tax liens, franchise or small businesses through the IRA LLC.
- Multiple Investors: When structured appropriately, an IRA LLC can allow you additional buying power and investment opportunities by combining investment capital from many sources.
Like all things, there are certain rules and regulations regarding IRA transactions that, if violated, can result in taxes and penalties. Regardless of whether you use a Self-Directed IRA or IRA LLC, the penalties are steep when it comes to prohibited transactions. It is extremely important to use a very experienced firm or qualified tax attorney in handling these sorts of transactions.
There are two primary reasons:
- Formation process: The formation of the LLC, and the investment by the IRA, needs to be completed in a particular process. If the IRA LLC is created in the wrong order, or if the LLC documents are not executed correctly, you can create a prohibited transaction. This could open you up to a potential IRS audit.
- Prohibited Transaction Analysis: LLC IRA facilitators should be familiar with prohibited transactions and have a duty to inform their clients when they see a potential violation. Although a Self-Directed IRA owner is ultimately responsible for avoiding a prohibited transaction, facilitators will try to offer input if they see a potential prohibited transaction.
What is UBTI & UDFI?
Unrelated Business Taxable Income (UBTI) & Unrelated Debt-Financed Income Tax (UDFI) as they relate to real estate purchases. Income earned by a tax-exempt entity that does not result from tax-exempt activities. The entity may owe taxes on this income.
In 1950, the IRS code was amended to include a provision called unrelated business taxable income or RE_UBTI. The tax on such income is called unrelated business income tax (UBIT).
Essentially, if a tax exempt entity (e.g., non-profit) engages in a business that is unrelated to its primary purpose, any income derived from such business will be subject to UBIT. IRAs are also subject to UBIT if they conduct unrelated businesses that produce profits.
For example, if an IRA forms an LLC to buy and operate a dry cleaner or gas station, businesses obviously unrelated to the primary purpose of an IRA, the net income will be taxed as UBIT (at the trust tax rate because an IRA is considered a trust under the tax code in this purpose). The change in the code was intended to level the playing field between tax-exempt organizations and for-profit organizations conducting the same businesses.
In addition, whenever debt is used by a tax-deferred or tax-exempt entity (with some exceptions), tax is applied to that portion of the gain that is debt-financed. This income is called unrelated debt financed income or UDFI, which is a subset of RE_UBTI. Taxes on both are calculated and reported on IRS form 990-T.
Any property held to produce income is debt-financed property if at any time during the tax year there was acquisition indebtedness outstanding for the property. When any property held for the production of income by a tax-exempt organization or IRA or Roth IRA is disposed of at a gain during the tax year, and there was acquisition indebtedness outstanding for that property at any time during the 12-month period before the date of disposition, the property is debt-financed property. In general, average acquisition indebtedness for any tax year is the average amount of the outstanding principal debt during the part of the tax year the property is held by the entity or IRA.
To calculate the average amount of acquisition debt, determine the amount of the outstanding principal debt on the first day of each calendar month during that part of the tax year that the organization holds the property. Add these amounts together, and divide the result by the total number of months during the tax year that the organization held the property.
The amount of gain or income taxable as UDFI for any tax year is the total income, multiplied by a fraction. The numerator is the average amount of acquisition debt, and the denominator is the average of the adjusted bases at the beginning and at the end of the year.
Before calculating the net income, certain deductions can be taken into consideration, just as they are when you purchase property outside of an IRA. For example, depreciation can be deducted, if applicable, but only on the straight-line method. For example, if the depreciation of an IRA-held building is $20,000 and the property is 70 % debt-financed, then 70% of the $20,000 overall depreciation (or $14,000) can be deducted from gross income, before calculating UDFI tax. To be directly connected with debt-financed property or income derived from it, the deduction must be clearly related to the property and its income.
Securities purchased on margin are considered debt-financed property.
Acquisition indebtedness is the outstanding amount of principal debt incurred by the organization to acquire or improve the property:
- Before the property was acquired or improved, if the debt was incurred because of the acquisition or improvement of the property.
- After the property was acquired or improved, if the debt was incurred because of the acquisition or improvement, and the organization could reasonably foresee the need to incur the debt at the time the property was acquired or improved.
An IRA purchased a residential rental property that produced $10,000 of gross rental income last year. The average adjusted basis of the rental during the year was $100,000, and the average indebtedness (e.g., bank mortgage) with respect for the rental property was $50,000. Thus, the relevant fraction was 50% and therefore the unrelated debt-financed income was $5,000 (50% of the $10,000).
The same property is sold at the end of the year and the average indebtedness was $50,000 over the twelve months prior to sale. Assuming the basis remained at $100,000, and that the property was sold for $140,000, and because the debt/basis ratio remains 50%, then 50% of the $40,000 gain or $20,000 will be subject to tax. Because the gain is a capital gain, the tax on this percentage of the gain will be determined according to the usual rules for capital gains and losses (e.g., long term gain tax is currently 15% after a one year holding period).
What is a prohibited transaction?
Per IRS Publication 590 a prohibited transaction is any improper use of your traditional IRA account by you, your beneficiary, or any disqualified person. The following are examples of prohibited transactions:
- Borrowing money personally from your IRA
- Selling property you already own to your IRA
- Using your IRA as security for a loan
- Buying property for personal use (present or future) with IRA funds
What is a disqualified person?
Disqualified persons include your fiduciary and members of your family (spouse, ancestor, lineal descendant, and any spouse of a lineal descendant).
What types of accounts can I self-direct?
Self-direction isn’t limited to IRAs. The following accounts can be self-directed:
- Traditional IRA
- Roth IRA
- SEP IRA
- SIMPLE IRA
- Rollovers and transfers to a retirement account
- Individual (k)
- Coverdell Education Savings Account (ESA)
- Health Savings Account
Why haven’t I heard of this before?
Traditional investment custodians will only allow account holders to hold investments that their firm offers. To date, they have had control of over 97% of the retirement accounts held by the public. They will commonly state that such investments are illegal or too complicated, but it may be in part to the inability of many brokers to provide the self-directed options that you want.
Can I purchase real estate that I or my corporation already owns with my self-directed IRA?
No. This is a prohibited transaction per IRC 4975. You may not purchase a property or an interest in a property that is currently owned by any disqualified person. Per IRS Publication 590: disqualified persons include your fiduciary and members of your family (spouse, ancestor, lineal descendant, and any spouse of a lineal descendant).
Can I invest funds in real estate from a self-directed IRA using an LLC?
Yes, you may use a special purpose LLC to purchase and hold title to investment real estate. This involves the forming of an LLC with the self-directed IRA as an owner or member of the LLC. It is important to structure the ownership of your LLC to ensure that your investments do not constitute a prohibited transaction. Always consult a qualified tax attorney or CPA to properly structure your LLC.
Can I obtain a mortgage to invest in a property with a self-directed IRA?
Yes, you may, but only with a non-recourse loan. Typically you must put down 30 percent to 35 percent to obtain the loan.
What is a non-recourse loan?
With a non-recourse loan, the note can only be secured by the property itself. It cannot be personally secured. The lender can only use the property as collateral to secure the note. If your IRA fails to make the loan payments, the only collateral the lending institution can come after is the property itself, and not the IRA. Please consult your tax adviser about any Unrelated Business Taxable Income (“UBTI”), and any taxes that may be due. Non-recourse loans with your self-directed IRA are a great way to help you to be able to diversify. Please contact us for more information about a non-recourse loan.
Can my IRA invest with other partners, including myself?
Yes, your IRA can invest with other partners and yourself individually. However, it is important to consult legal counsel in these situations to observe formalities and rules that may be associated with that investment.
Can Provident provide tax or legal advice regarding your investment?
No. If you should need tax or legal advice regarding your investment, you may engage a specialized tax law firm to provide the needed advice. Attorney-client privilege would exist between you and the firm, not Provident.
What’s special about the Solo 401k?
There are several unique advantages offered by the Solo 401k. They include:
- Significant tax deductible contributions (up to $46,000 in 2008 or $51,000 if age 50 or older). Depending on income, the Solo 401k may allow twice as much (or more) tax deductible contributions, when compared to other self employed retirement plans.
- Solo 401k loans are permitted. 50% of the assets of the Solo 401k ($50,000 maximum) may be borrowed using a Solo 401k loan. Money is available when needed tax free and penalty free, so the Solo 401k enables immediate tax savings and builds a source of funds that can be tapped in an emergency.
- The most generous “catch up” contributions for those 50 or older.An extra $5000 for a Solo 401k vs $0, $1000, or $2500 for a SEP IRA, IRA, or SIMPLE IRA respectively.
- Flexible funding requirements. Once established, no contribution is required in any year if financially inconvenient. There is a maximum annual Solo 401k contribution, but no minimum required contribution. The contribution flexibility of a Solo 401k eliminates potential funding worries if there is a bad business year.
- Simplicity – both to set up and maintain. Administration is minimal because complex discrimination tests are not required as with corporate 401k plans. IRS Form 5500 does not need to be completed unless plan assets exceed $250,000.