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Self-Directed IRA – Prohibited Transactions and Investments

While a Self-Directed IRA gives you enormous freedom in managing your retirement portfolio, make sure you do not get carried away. There are certain transactions and investments that are prohibited in a Self-Directed IRA. If you inadvertently create a PT, it could be very costly. What most people don’t understand is this: a minor prohibited transaction can cause the entire self-directed IRA to be distributed. For example, a $10,000 PT could cause a $100,000 IRA distribution. On top the income tax owed, there could also be fines and/or penalties.

investments prohibited by IRA

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Transactions that are prohibited in a Self-Directed IRA

Certain transactions are prohibited under a Self-Directed IRA. The IRS prohibits a self-directed IRA to enter into a transaction with a disqualified person. A disqualified person cannot receive any immediate benefit nor extend any immediate credit to the self-directed plan.

Disqualified persons are generally related parties and include fiduciaries, IRA holder, and spouse of the IRA holder, ancestors and lineal descendants. An entity in which the IRA holder has equity or management interest is also a disqualified person.

Some transactions, which may qualify as prohibited, include:

  1. The IRA holder, or his family member or an entity that is actively controlled by the IRA holder either buys, sells or even lease a property to / from the IRA.
  2. A self directed IRA cannot avail paid services from the IRA holder, his relatives or an entity wherein the IRA holder has significant majority equity interest.
  3. An IRA cannot lend or borrow money from the IRA holder or any other disqualified person for that purpose.
  4. A disqualified person personally guarantee a loan benefiting the IRA.
  5. The IRA account holder or any other disqualified person stays at a vacation rental home owned by the IRA. Such a stay whether paid for by the IRA holder at prevailing rates or made for free is a prohibited transaction.
  6. If the IRA account holder pledges the IRA account as a security against a loan, then the extent of the IRA funds pledged could be considered a distribution and attract the appropriate tax and/or penalties.
  7. If the IRA holder is a licensed real estate agent, any commissions paid for IRA real estate purchases, cannot be paid to any disqualified person. Even if the commission is considered fair and reasonable, such payment would be a PT.

Separate from prohibited transactions are certain investments not allowed using a self-directed IRA. The range of investment options available using a self directed IRA are extremely varied but the IRS has explicitly identified prohibited investments.

If the IRA invests money in prohibited investments, the extent of money invested in such options is considered distributed. The list of prohibited investment options includes collectibles, which include artworks, stamps, certain coins, metals and antiques. An IRA is also not allowed to hold shares in an S-corporation or purchase life insurance contracts. An IRA is also not allowed to hold a derivative position that carries unlimited risk.

At Self Directed Retirement Plans LLC, we take the time to explain the benefits a self-directed IRA offers. We also explain prohibited transactions and disqualified persons. The rules are not hard to adhere to. Our clients call us whenever they are not sure and we go over their concerns.