A Chance to Direct

Violate any of these boundaries and the Internal Revenue Service may treat the investment as an early withdrawal, taxing it as ordinary income and adding on a 10 percent penalty. To be safe, use an adviser to help navigate the rules, and if you suspect that a potential investment may be questionable, seek advance approval. and don't get carried away: a self-directed account appeals to those who feel they are astute, but the rule of "diversify, diversify, diversify" still applies. Isdale recommends that no more than 25 percent of your retirement portfolio be channeled into a self-directed IRA.

Taxes and Taxing
A smart IRA strategy always takes into account tax strategies, and that's true for self-directed IRAs as well. For any investment to make sense in an IRA, the benefits of tax deferral should outweigh the tax bill that applies if the investment is treated as a capital gain or ordinary income. And because of those tax rules, "there are just some investments that might not be appropriate," says Fiduciary Trust's Holdway.

For example, investing in a limited partnership may bring up the tricky problem of unrelated business taxable income. A partnership or LLC is known as a "pass-through" entity, explains Holdway, meaning that net earnings come from the business, not from the appreciation of stock. In such cases, the IRS treats the earnings as business income, not investment income, and levies taxes at the trust income-tax rate of 35 percent.

Even if you've addressed tax risk, there is always the question of investment risk. Patriot Federal Bank's initial public offering was nine months ago, but the stock is still not traded on the pink sheets. Fazio plans to stand by his choice, however, and says he will continue to make the standard annual contribution to his IRA (currently $4,000), with his bank a key investment target. After all, IRA investments are for the long term. And, as Fazio says, "I'm just too busy running the bank."

Lori Calabro is a deputy editor of CFO.

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