Self-Directed IRA Rules, Requirements, and Prohibited Transactions

Keeping your self-directed IRA in a tax-advantaged environment.

Complete Responsibility and Control of Your Investments

Self-directed IRAs give you great power to invest in alternative assets. These may be assets you are already familiar with such as real estate, private placements, IRA LLC, and many more. But with great power comes great responsibility.

It is very important to know that as a self-directed investor you are responsible for making all the decisions and investment choices for your IRA. Your self directed IRA custodian is not responsible for vetting your investment choices. Also, you are responsible for making sure you do not break the rules that keep your self-directed IRA in a tax-enhanced environment. Here are some details that will help you understand the rules. 

3 Self-Directed IRA Rules You Should Never Break

Breaking the rules can result in severe tax consequences. Whenever you are unsure of a transaction or situation, always consult with a tax or financial advisor before you act to get clarification. Here are the main rules that you should remember when engaging in a transaction with your self-directed account.

1. Disqualified Persons

The IRA investor or his or her beneficiaries cannot engage in a transaction with a disqualified person. These persons are listed below. When you break this rule, your IRA is no longer an IRA and it loses its tax benefits. 

2. Personal Benefit

The IRA investor cannot use the self-directed IRA for personal benefit. For example, rental income from an investment property owned by the IRA must be deposited in the IRA account and not in a personal account. All income from IRA assets must be put back in the IRA.

3. Disallowed Investments

The IRA investor cannot invest in disallowed assets per IRS rules for retirement accounts. Disallowed IRA assets or investments are explained further below.

What is a Disqualified Person?

Disqualified Persons are people or entities that cannot do any direct or indirect deals, investments or transactions with the IRA.

The IRA cannot do business with:

  • You, the IRA owner
  • Beneficiaries of your IRA
  • Your family members:
    • Spouse
    • Parents
    • 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 disqualified person
  • 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

Allowed and Disallowed Investments in a Self-Directed IRA

Self-directed IRAs give you the freedom, flexibility, and choice of how to invest your hard-saved dollars. You can expand and diversify your investment opportunities beyond the stock market into a variety of alternative investments, such as  mortgages, notes, real estate, and private placements.

These alternative investment options have been available since 1975, when IRAs were introduced as part of the Employee Retirement Income Security Act of 1974. However, there are some assets that are not allowed.

It comes as a surprise to many investors that there is no list of approved investments for retirement accounts. However, the IRS does have a list of what the law does not allow as an investment in a retirement account.

All IRAs including self-directed IRAs cannot invest in:

Collectibles

This includes any: work of art, rug or antiques, certain metals, gems, stamps and certain coins, alcoholic beverage, and any other tangible personal property that is a "collectible" under IRC Section 408.

Life insurance

Per the Internal Revenue Code 408 (a)(3) for an individual retirement account, an IRA cannot invest in life insurance. 

S-Corporations

Trusts that qualify as an IRA are not eligible to be shareholders of an S-Corporation. (See Revenue Ruling 92-73)

Self-Directed IRA Prohibited Transactions & Requirements

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 account 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 as an investment
  • Transfer IRA income, assets, or investment to a 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 investment(s) for their own interest

Self-Directed IRA Rules

Are the rules for self-directed IRAs different? 

What are the requirements to open a self-directed IRA? 

Almost anyone can open an IRA account. All you need is a copy of a government issued identification and a credit card to pay for the account establishment fee. You can establish the retirement account yourself. However, to make contributions to your IRA you (or your spouse) must have earned taxable income.

What is the IRS code for self-directed IRAs? 

All individual retirement accounts including self-directed IRAs are covered under Internal Revenue Code 408.   This section of the code covers the type of investment NOT allowed in IRAs as well as other general rules. Engaging in a transaction that violates these rules can lead to tax consequences .

Learn the Basics of Self-Directed IRAs Before You Get Started

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