Self-Directed IRA Rules and Prohibited Transactions
Self-directed IRAs give you great power to invest in non-traditional assets. Assets you understand such as such as real estate, private placements, and many more. But with great power comes great responsibility. It is very important to know that:
- You are responsible for making all the decisions for your self-directed IRA.
- You are responsible for making sure you do not break the rules that keep your IRA in a tax-enhanced environment.
Breaking these rules can result in severe tax consequences. Whenever you are unsure of a transaction or situation, always consult with a financial professional before you act to get clarification.
Top 3 self-directed IRA rules to keep in mind:
- You cannot engage in a transaction with a disqualified person.
- You cannot use the IRA to take personal benefit.
- You cannot invest in disallowed investments.
What is a Disqualified Person?
Disqualified Persons are people or entities that cannot do any direct or indirect transactions with the IRA. The IRA cannot do business with:
- You, the IRA owner
- Beneficiaries of your IRA
- Your family members:
- Grandparents and great-grandparents
- Children and their spouses
- Grandchildren, great-grandchildren, and their spouses
- Service providers of the IRA including those that give investment advice concerning the assets for which he/she receives direct or indirect compensation
- An entity—it could be a corporation, partnership, limited liability company, trust or estate—owned 50% or more (directly or indirectly) by a DP
- An officer, director (or an individual having powers or responsibilities similar to those of officers or directors), a 10% or more shareholder, or highly compensated employee (earning 10% or more of the yearly wages of an employer) of a person described above
Self-Directed IRA Prohibited Transactions
Your retirement plan is intended to benefit you when you retire, and not a moment before you reach that magic age. Transactions that the IRS interprets as providing you immediate, personal financial gain on investments owned by your retirement plan are not allowed.
Making a prohibited transaction or dealing with a Disqualified Person strips away the tax-deferred feature of your account. This makes the transaction automatically and immediately taxable. (See IRC Section 4975 for a complete list of prohibited transactions.)
Examples of Prohibited Transactions
You cannot use your self-directed IRA to:
- Sell, exchange, or lease property you already own to your IRA
- Transfer IRA income or assets to Disqualified Person
- Lend IRA money or extend IRA credit to Disqualified Person
- Supply goods, services, or facilities to Disqualified Person
- Allow fiduciaries to obtain or use the IRA’s income or assets for their own interest
Allowed and Disallowed Investments in Self-Directed IRAs
It comes as a surprise to many people that there is no list of approved investments for retirement plans. However, the IRS does have a list of what the law does not allow as an investment. Self-directed IRAs cannot invest in:
- Collectibles: Art, antiques, gems, coins, or alcoholic beverage, and certain precious metals
- Life insurance (See IRC Section 408(a)(3))
- S-Corporations: Trusts that qualify as an IRA are not eligible to be shareholders of an S-Corporation. (See Revenue Ruling 92-73)
Other important rules regarding self directed IRAs to keep your account compliant:
For more information on investments not allowed in retirement plans and how to protect your account visit the IRS website. Give us a call if you have an investment in mind or set up a free consultation at your convenience.