Self-directed investing broadens the realm of opportunity for your tax-advantaged retirement accounts, expanding your portfolio and placing the full power of diversification in your hands. Real estate, private equity, and other alternative investment options are all available to your IRA, 401(k), or Health Savings Account. Within self direction lies a specific investment approach that offers even greater flexibility while tasking the account holder with more management responsibility: the Checkbook IRA.
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A Checkbook IRA is not a distinct type of account the way Traditional IRA, Roth IRA, and others are. The term “checkbook” is an industry term to designate an account that provides “checkbook control” to the account holder.
Checkbook control means you can directly fund new investments that are “owned” by a business entity (e.g. an LLC), which is “owned” by your self-directed account. With this account structure you can personally execute investment activities without coordinating each one through your account custodian (NDTCO).
To exercise checkbook control in an account, the holder must:
Why would an investor choose a Checkbook IRA? Let’s use an example of purchasing investment property to illustrate. You would determine the terms of the purchase and generate the real estate contract, but, without checkbook control, the contract would need to come to NDTCO and we would need to issue your account funds to execute the transaction. Thereafter, any expenses incurred by the property would have to be paid by the account and coordinated through NDTCO as well.
On the other hand, a Checkbook IRA would enable you to perform these activities yourself. Once your account-owned business entity is funded and you’ve taken checkbook control, you would be able to issue payment to fund the investment and easily pay future expenses without having to coordinate with NDTCO.
This increased level of control over your investments may seem enticing. However, it’s critically important to understand and follow the IRS rules, none of which change with checkbook control. Prohibited transactions and self-dealing rules still apply; you must maintain arm’s-length distance between yourself and your tax-advantaged assets, even with a hands-on approach.
Your personal money and your tax-advantaged money must never comingle. For instance, if you receive a payment for your account-owned rental property, this money must go back to the account-owned business entity that "owns" the property. Under no circumstances can you retain this money on a personal basis, use your personal money to cover property expenses, or use the property for personal use.
Because checkbook control puts you much closer to the operations surrounding your investments, prohibited transactions—regardless of whether they’re intended or unintended by the account holder—can be more difficult to distinguish and avoid. Furthermore, because your account custodian would not be directly involved in your transactions, you won’t have an extra pair of eyes to pre-emptively catch activities that the IRS will frown upon.
With these cautions in mind, a Checkbook IRA may be appropriate if your financial strategy warrants a heightened degree of participation. Like other investments, due diligence, risk tolerance, and a thorough understanding of the applicable rules can help guide your investment path.
Click here to join our live webinar, A Close Look at Checkbook IRAs, on Tuesday, January 5 at noon, Mountain Time to learn more about these fascinating account types.
If you ever have questions or concerns about the permissibility of a prospective investment action, please don’t hesitate to contact us by sending us a secure message via the client portal at portal.ndtco.com or give us a call at 877-742-1270.