Learn more | Self-Directed IRA Rules
Self-Directed IRA Rules & Prohibited Transactions
Self-Directed IRA Prohibited Transactions
Retirement investors must be aware of the prohibited transaction rules prior to making an investment. If you do not follow the rules, it can lead to the disqualification of the retirement account. The IRC (Internal Revenue Code) does not state what investments you can make, only what investments you cannot make. An IRA holder cannot purchase life insurance or collectibles with his or her IRA funds. Additionally, IRA holders cannot engage in direct or indirect prohibited transactions. You must also be aware of disqualified persons. Your IRA funds cannot be used to benefit any disqualified person, which includes you, the IRA holder.
Prohibited transactions full under three primary categories:
- Direct prohibited transactions
- Self-dealing prohibited transactions (indirect)
- Conflict-of-interest prohibited transactions
When there is a prohibited transaction, there is always a disqualified person on the other side of the transaction.
The majority of Self-Directed IRA prohibited transaction rules pertain to transactions with disqualified persons. The reason that transactions with disqualified persons are prohibited is because the IRC views such dealings as suspicious, therefore should not be allowed.
The definition of a disqualified person extends in a variety of scenarios that can be complex. Disqualified persons include the IRA holders and his/her lineal descendants. It also includes entities of which disqualified persons own 50%.
Direct Prohibited Transactions
A direct prohibited transaction is between a disqualified person and his/her retirement account. For example, Pete, a disqualified person, uses his Self-Directed IRA funds to purchase interest in an entity his father owns (a disqualified person).
This transaction entails two disqualified persons, and one disqualified person benefits from the transaction. This is a direct prohibited transaction.
Self-Dealing (indirect) Prohibited Transactions
Self-dealing prohibited transactions concern an individual who uses his or her IRA funds for personal gains. For example, Doug, the IRA holder and a disqualified person, uses his Self-Directed IRA funds to invest in his son’s business (a disqualified person) that is in financial turmoil. Doug is using his retirement funds for personal interests; therefore, this is a prohibited transaction.
Conflict-of-Interest Prohibited Transactions
A conflict-of-interest prohibited transaction involves a disqualified person who is also a fiduciary and is connected to a transaction that involves the income or assets of the individual’s IRA.
For example, Francine uses her IRA funds to loan money to a company she owns a small interest in. However, she also manages and controls its daily operations. Francine is the fiduciary, thus has a close connection to the investment and benefits from the transaction. As a result, this is a conflict-of-interest prohibited transaction.
Prohibited transaction rules exist so individuals do not directly or indirectly benefit from transactions regarding their individual retirement account. These Self-Directed IRA rules are primarily in place so investments involving your IRA can benefit the retirement account, not the owner.
Below are the following IRC provisions. Each of these rules fall under different Internal Revenue Code sections.
- Prohibiting IRAs from investing in life insurance contracts.
- Referencing tax on prohibited transactions.
- Defining an IRA’s loss of tax-exempt status upon engaging in a prohibited transaction.
- Describing effect of pledging an IRA or any IRA assets as security for a loan.
- Expressing impermissible investment in collectibles.
- Describing unrelated business taxable income.
- Imposing tax on unrelated business income.
- Describing an unrelated trade or business.
- Individual Retirements Arrangements (IRAs)
- Swanson v. Commissioner (1996)
We wrote the book on Self-Directed IRAs
The second installment in a four-part series, The Checkbook IRA: Why You Want it, Why You Need it, explores important topics regarding the self-directed IRA and why it has become the leading retirement structure to purchase real estate using IRA funds.
Following the success of Adam Bergman’s previous self-directed IRA book comes Self-Directed IRA in a Nutshell, a straightforward explanation on what IRA investors need to know about self-directed IRA retirement structure.