Self-directed IRAs give you more freedom to invest than most people believe is possible. After being stuck with traditional providers offering the typical public stock and bonds, it’s almost unimaginable the flexibility you have with an IRA Resources account. The right to invest as you wish is one of the main reasons our special niche of the financial industry is growing faster and faster every year. Though you can invest in almost any way you choose, there are still a few things the IRS says you can’t do with a self-directed IRA— or else risk your tax-advantaged status.
Though you’ve got quite a lot of freedom in a self-directed IRA, the IRS has a few specific exclusions. These are known as prohibited transactions and disqualified persons. Any transaction with a disqualified person is also a prohibited transaction— and doing either within your IRA puts the tax-status of your account at risk.
The IRS’ position is your retirement fund is meant to benefit you when you retire, and not a moment before. Because of this, the IRS does not want investors to personally benefit from anything the IRA does. By disallowing specific transactions, they aim to enforce an “arm’s length” standard, where you are not directly working with or benefiting from your IRA.
It’s very important you follow these rules— if you are found to have completed a prohibited transaction, your IRA will be forcibly distributed and lose its tax-protected status. The account will be immediately taxable and you will owe taxes and penalties on the amount, starting from the year of the original prohibited transaction (no matter when the transaction is discovered).
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A disqualified person is anyone the IRS has decided is not “arm’s length” from the IRA. Your IRA cannot engage in any transactions with these individuals (with a few exceptions, like when you partner your IRA on a new transaction) or you risk the tax-status of your IRA.
A Disqualified Person is:
The IRS does not consider siblings, cousins, aunts and uncles, or step-children as disqualified persons, so you can invest with them as if they are any other individual.
The important thing to remember is that the IRS is trying to prevent you (or you, through your family) from benefiting directly from the IRA, at least until you’ve retired and distributed those funds. That’s what these rules are designed to prevent— and if you keep that in mind, it should be easy to avoid these errors.
There are a few specific types of investments your self-directed IRA cannot hold, as decided by the IRS.
These are:
In addition, any transaction between your IRA and a disqualified person (including the IRAs beneficiaries) is considered a prohibited transaction. This would be referred to as “self-dealing” and is not allowed. Any interaction with your IRA must be an arm’s length transaction where you personally are not benefiting from the actions of the IRA. You are also not allowed to perform work on the asset yourself that would save you on costs— this is referred to as “sweat equity” and is prohibited with your IRA investments.
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Investing with a self-directed IRA could be exactly what your retirement needs to live the future you want— but you’ve got to follow the rules to get there. Being aware of the few things that aren’t allowed in your IRA is essential when it comes to protecting yourself and your account. Based on the growing number of self-directed investors each year, investors are finding ways to make excellent returns, despite the prohibitions. Is there anything else you’d like to ask? Call us, our Certified IRA Services Professionals (CISPs) are eager to help 888-322-6534.