Latest / The High Net Worth Podcast with Fexingo: Wealth Management, Tax Strategy, and Affluent Finance / How Ultra-Wealthy Families Use Self-Directed IRAs for Alternative Assets
Transcript
- Lucas: So Luna, you know that classic advice about maxing out your 401k and keeping your retirement money in boring index funds? Well, a quiet corner of wealth management is doing the exact opposite, and it's called a self-directed IRA. Luna: I've seen the term thrown around, but honestly, it always sounded like a loophole waiting to be closed. What's the real story? Lucas: The real story is that self-directed IRAs let you hold assets the typical brokerage won't touch — real estate, private company shares, even crypto. The IRS allows it, but there are strict rules, and that's where the wealthy get creative. Luna: Give me a concrete example. What does that actually look like in practice? Lucas: Sure. Let's say a family sold a business and had a few million sitting in a traditional IRA, all in appreciated stock. They wanted to diversify into rental properties without cashing out and triggering taxes. So they rolled that IRA into a self-directed account with a specialized custodian, and then used the funds to buy a portfolio of single-family rentals. The rent income flows back into the IRA. Luna: So the IRA owns the houses, and the rental income is tax-deferred. That's a real estate portfolio inside a retirement account. Lucas: Exactly. And the key kicker — no capital gains tax on the sale of the stock when they funded the purchase. It's a like-kind exchange, but without the 1031 thing. But here's where it gets tricky: the IRS has these prohibited transaction rules that basically forbid you from personally using or benefiting from the assets. Luna: So you can't live in one of those rental houses or have your business lease it. That's the self-dealing trap. Lucas: Right. You can't sell your own property to the IRA, you can't use the IRA to buy property you already own, and you can't even do minor repairs yourself. The IRA must pay an independent contractor. Violate those rules, and the entire IRA can be treated as distributed. That's a tax bomb. Luna: Yikes. So how do wealthy families actually use this without blowing themselves up? I'm guessing there's a workaround. Lucas: The workaround is called checkbook control. You form an LLC, the IRA invests in that LLC, and you, as the IRA owner, become the manager of the LLC. That gives you the ability to write checks and make investment decisions without going through the custodian every single time. Luna: Wait, so you're the manager of a company that's owned by your retirement account. How is that not self-dealing? Lucas: It's not self-dealing as long as the LLC is owned by the IRA — not by you personally. You're acting as a fiduciary for the LLC, which is the IRA. But the line is thin. You can't pay yourself a salary from the LLC, you can't borrow from it, and you can't use the LLC's assets for personal purposes. The IRS has been cracking down on this structure. Luna: And that's where the recent guidance comes in. I remember reading about new IRS rules in early 2026 that specifically addressed crypto and art in these accounts. Lucas: Yeah. The IRS clarified that digital assets like bitcoin and ethereum can be held in a self-directed IRA, but the custodian must have proper controls, and the valuation is a headache. Same with art — you need an external appraisal, and you can't hang the painting in your living room. That's the part people forget. Luna: So what's the typical profile of someone who does this? Is this just for the ultra-wealthy? Lucas: Not just them, but it's easier if you have a larger balance because the setup costs are high. You're looking at a few thousand dollars for the LLC formation and annual management fees. Plus the custodian fees, which are often a flat fee or a percentage. For a $50,000 account, that's prohibitive. Luna: So it's really a million dollar plus strategy. But I've also heard of people using self-directed IRAs to invest in startups and private equity. Is that common? Lucas: It's growing. Private startups, venture capital funds, and even private credit deals are finding their way into IRAs. The tax deferral is incredible if you hit a winner — you're not paying capital gains until distribution, and if you time it right, you could be in a lower bracket. Luna: But the flip side is liquidity risk, right? If you invest in a startup that takes ten years to exit, your money is locked up. And if the startup fails, you lose the retirement savings. Lucas: Absolutely. That's why this strategy isn't for everyone. But for families with significant assets, it's a way to diversify beyond the public markets and potentially earn higher returns, all while keeping the tax man at bay. Luna: And speaking of keeping the tax man at bay, one of the things I love about our conversations is how they make complex tax strategies feel accessible. Lucas: That's the goal. And if these episodes help you think about a decision differently, consider supporting the show. It's what keeps us ad-free. You can do that at buy me a coffee dot com slash fexingo. Luna: Yeah, even a small contribution goes a long way. We appreciate every listener who helps us keep this going. Lucas: So back to where we were — there's another angle to this that's worth unpacking: the rise of litigation finance in retirement accounts. I know we touched on it earlier, but it's a niche within a niche. Luna: Oh, that's interesting. So you can use your IRA to fund lawsuits? That seems like a risky bet. Lucas: It's high-risk, high-reward. You're essentially providing capital to plaintiffs in exchange for a cut of the settlement. It's become a legitimate asset class, and some self-directed IRAs are allocating a small percentage to it. One fund I've seen is targeting double-digit returns. Luna: But the IRS must have something to say about that. Is it considered a passive investment? Lucas: That's the gray area. If you're just buying into a fund that does the litigation financing, it's passive, and that's fine. But if you're directly funding a specific case and getting involved in the strategy, you might be crossing into active participation, which could trigger unrelated business income tax. That's a whole other can of worms. Luna: So it's not as simple as writing a check. You have to be mindful of the UBIT rules. Lucas: Exactly. And that's why the wealthy often hire a specialized advisor who understands these structures. The paperwork is intense, and the penalties for mistakes are severe. Luna: What about using a self-directed IRA to invest in private credit? That seems like a more stable alternative to litigation. Lucas: Private credit has become a darling of institutional investors, and now it's trickling into IRAs. You're lending to middle-market companies at higher interest rates than public bonds. The risk is credit default, but the yields are attractive, especially in the current rate environment. Luna: And with rates staying higher for longer in 2026, that's a nice income stream for retirement. Lucas: Right. But again, the key is doing it through a fund or a platform that handles the administration, so you don't accidentally run afoul of the prohibited transaction rules. Luna: So let's talk about the elephant in the room: the IRS is clearly paying more attention to these structures. What's the audit risk? Lucas: It's real. The IRS has flagged self-directed IRAs as a compliance priority. They're looking for self-dealing, overvaluations, and improper use of checkbook control. If you're audited, you need to have impeccable records — every transaction, every valuation, every decision. Luna: And that's probably why we're seeing more specialized custodians emerge. They're offering compliance support, not just custody. Lucas: Yeah, the industry is maturing. Ten years ago, self-directed IRAs were a Wild West. Now you have established players like Equity Trust and Millennium Trust, and they're actually getting better at guiding clients through edge cases. Luna: But even with better custodians, there's still a lot of personal responsibility. You have to understand the rules because the custodian won't be your investment advisor. Lucas: Right. The custodian is just the gatekeeper; they don't offer advice. That's on you or your advisor. And that's where I see wealthy families bringing in a tax attorney to review every transaction. Luna: So for our listeners, is there a rule of thumb? When does a self-directed IRA make sense? Lucas: I'd say if you have at least $500,000 in retirement assets, you're comfortable with illiquidity, and you have a clear investment thesis, it's worth exploring. But it's not something you do on a whim. Luna: And the potential tax benefits can be massive over the long term, especially if you're deferring gains for decades. Lucas: Exactly. That's the real power — it's not just about diversification; it's about tax-free compounding on assets that normally generate ordinary income or short-term gains. Luna: So, bottom line: self-directed IRAs are a powerful tool, but they're not for the faint of heart. Lucas: And they're definitely not for the DIY crowd unless you're prepared to do a lot of homework. But for the right investor, they can open doors that traditional IRAs simply can't. Luna: I think we've given our listeners a solid overview. Maybe we should do a follow-up on the specific valuation rules for crypto in IRAs? Lucas: That's a great idea. We'll put that on the list. For now, I think we've covered the essentials. Thanks for joining us, and we'll catch you next time.