Last updated on March 29th, 2020
Written by: Rick Pendykoski
You might have the strong instinct of spotting the right investment opportunities in real estate or other asset classes, but you fail to reap the benefits because your traditional IRA limits your investment options, not allowing you to invest in that asset class. In a traditional IRA, the range of investment options is mostly limited to certificates of deposit, mutual funds, stocks, or bonds. On the other hand, a Self-Directed IRA empowers you to invest in a wide array of investments, which, if wisely managed, can help you maximize your portfolio returns.
The need to have a variety of investment alternatives really becomes apparent when you see the value of your portfolio diminishing because of sudden stock market crashes, or the yields on corporate bonds have fallen to dismal levels. The host of investment choices that are available in a self-directed IRA empowers investors to leverage their knowledge and awareness to choose the investment option that looks most lucrative at that point in time.
What Can I Invest in With a Self-Directed IRA?
- Lease Options
- Raw Land
- New Construction
- …and much more
- Charitable Entities
- Tax Liens
- Discounted Notes
- …and more
- Limited Partnerships
- Mutual Funds
Self-Directed IRA Prohibited Transactions and Investments
What is a Prohibited Transaction?
A prohibited transaction is a transaction carried out by you, the disqualified person, using your IRA in a way that is prohibited by law.
Who is a Disqualified Person?
A disqualified person is any of the following:
- You, the account owner
- Your spouse
- Your lineal descendants/ascendants and their spouses
- Fiduciaries and plan service providers that include custodians, advisors, and administrators
- An entity (estate, corporation, partnership, etc.), where you directly or indirectly own at least 50% of the voting stock
- A director, officer, or 10% or more shareholder or partner.
What Investments Are Not Permitted by the IRS?
Although a self-directed IRA offers a wide range of investment options, the IRS restricts investments in the following Collectibles (see below), Shares of an S Corporation and Life Insurance Contracts.
- Metals (except for silver, gold, palladium, and platinum bullion)
- Coins (except for gold and silver coins minted by the US Treasury Department)
- Alcoholic Beverages
What Are the Potential Consequences If You Fail to Adhere to IRS Rules for Prohibited Transactions?
Although a Self-Directed IRA offers a wider range of investment options than other retirement accounts, it is important that you adhere to IRS rules for prohibited transactions. If you violate any of these rules, you may have to suffer from serious or costly consequences.
- If you carry out a prohibited transaction at any time during the year, the IRA loses its tax-favored status as of the first day of that year.
- The IRS considers your account to be ‘fully distributed’ (100% of the value of the IRA is considered distributed) as of the first day of the taxable year in which the prohibited transaction took place. Since your entire IRA is fully distributed, you are liable to pay tax based on a combination of penalties, income taxes, and interest on your entire IRA value as of January 1 in the year when the prohibited transaction occurred.