Self-Directed IRA Rules, Requirements, and Prohibited Transactions

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.

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)