But the tax rules surrounding self-directed IRAs are tricky, the penalties for violations can be punishing, and the IRS recently started requiring custodians, in their annual filings, to flag accounts holding alternative assets. At the same time Congress’ Government Accountability Office is studying self-directed IRAs to see how they’re used and if more restrictions are needed.
Seattle tax attorney Warren L. Baker, 37, has spent a decade building a national practice advising owners of self-directed IRAs. He sees both the potential and the peril. One client inherited a $10 million IRA that has grown into a $50 million IRA largely through private equity investments. Another turned a $200,000 Roth IRA into a $10 million tax-free retirement kitty by buying raw land on the edge of a Midwestern city, selling at a profit and investing in more land.
“For the real estate guy driving around looking for deals, it’s not that much of a stretch for him to have his IRA buy property,” Baker says, adding that his typical client prefers investing in areas where he has expertise over investing in the broad stock market.
Example: One client, an engineer, used his IRA to invest in Vicis, a three-year-old Seattle company that has developed a high-tech football helmet to reduce head injuries. The company’s cofounders include an engineering professor and a pediatric neurosurgeon, and its list of 250-plus investors–it has raised more than $20 million–includes dozens of doctors, current NFL players and Roger Staubach, the legendary Dallas quarterback turned real estate entrepreneur.
That’s the promise. The peril? Baker estimates that half of those with self-directed IRAs are violating one or another IRS rule, usually without even realizing it. “If you’re handed a gun, you shoot your foot if you don’t know how to operate it,” he says.
No, Baker isn’t urging all retirement savers to hire $400-an-hour lawyers like him for safety lessons. Instead, he says, those without a good investment reason to hold alternative assets should stick to conventional IRAs. That’s what he does.